State backlash against a restriction in the $1.9 trillion economic relief legislation that prohibits local governments from using aid money to cut taxes emerged as the Biden administration’s first major legal battle on Wednesday, as Ohio sued to block the provision and other states considered similar action.
The litigation came amid growing pushback from Republican lawmakers and state officials, who say that the strings attached to the Covid relief money are a violation of state sovereignty and that imposing tax cut restrictions is an infringement on a state’s right to set its own fiscal policies.
On Tuesday, 21 Republican attorneys general wrote a letter to Treasury Secretary Janet L. Yellen seeking clarity on the portion of the law that prevents them from using the federal funds “to either directly or indirectly offset a reduction in the net tax revenue” resulting from state tax cuts.
The attorneys general called the provision “the greatest attempted invasion of state sovereignty by Congress in the history of our Republic.”
The fight could slow the rollout of more than $200 billion in relief funds that states are expected to receive to help cover Covid-related costs, including money for schools and infrastructure investments.
States, which are expected to share $220 billion worth of stimulus funds, are anxiously awaiting guidance about whether the restrictions apply to the use of federal dollars to offset new tax cuts, or if it blocks them from cutting taxes for any reason, even if the cuts were in the works before the law passed.
In a court filing on Wednesday, Dave Yost, Ohio’s attorney general, sought a preliminary injunction that would bar the federal government’s ability to enforce what he described as the “tax mandate.”
“The federal government should be encouraging states to innovate and grow business, not holding vital relief funding hostage to its preferred pro-tax policies,” Mr. Yost, a Republican, said in a statement.
Ohio is expected to receive $5.5 billion in federal relief funds. Mr. Yost said that states should not have to choose between accepting the money and maintaining their rights to cut taxes.
But the Treasury Department said on Wednesday that if a state that took relief money cuts taxes, that state must repay the amount of lost revenue from those cuts to the federal government.
“It is well established that Congress may establish reasonable conditions on how states should use federal funding that the states are provided,” said Alexandra LaManna, a Treasury spokeswoman. “Those sorts of reasonable funding conditions are used all the time — and they are constitutional.”
She added that the new law “provided funds to help states manage the economic consequences of Covid-19, and gave states flexibility to use that money for pandemic relief and infrastructure investments.”
The Treasury Department rejected the idea that the provision, which was added to the relief legislation at the last minute, was prohibiting states from cutting taxes. States are free to decline the federal funds, or they can repay the money if they are in fiscal shape to cut taxes.
“The law does not say that states cannot cut taxes at all, and it does not say that if a state cut taxes, it must pay back all of the federal funding it received,” Ms. LaManna said. “It simply instructed them not to use that money to offset net revenues lost if the state chooses to cut taxes. So if a state does cut taxes without replacing that revenue in some other way, then the state must pay back to the federal government pandemic relief funds up to the amount of the lost revenue.”
The amount of aid that a state will receive is tied to its jobless rate, and there are strict requirements to ensure that the money is used for purposes related to the coronavirus or to offset revenues that have been lost because of the health crisis. The Treasury Department plans to closely scrutinize how the money is spent.
In their letter to Ms. Yellen, the attorneys general said that if they did not receive a formal response by March 23, they would take “appropriate additional action.”
More lawsuits could soon follow. Attorney General Patrick Morrisey of West Virginia said such action would include seeking a court ruling “that the unprecedented and micromanaging provision violates the U.S. Constitution.”
At a briefing with reporters on Wednesday, Mr. Morrisey said he had been working on a draft of a complaint. He has been talking to other states about the mechanics of the legal challenge and where it should be filed.
“There are huge legal and constitutional problems with this provision,” Mr. Morrisey said. “This may be one of the greatest attempted invasions of state sovereignty by Congress in the history of our Republic.”