Can the federal government directly tax state and local governments? The U.S. Supreme Court answered other questions in its recent ruling on the Affordable Care Act but left this unresolved. Through a separate lawsuit, my office and 39 Indiana school districts filed in U.S. District Court, we seek an answer.
Several interconnected portions of the Affordable Care Act and court decisions led to this point. The Supreme Court in 2012 ruled the individual mandate to buy insurance or pay an IRS penalty is constitutional only if understood to be a “tax.” The act also includes an employer mandate where large employers must offer health insurance or face a massive IRS tax penalty if even one employee receives a tax credit subsidy from the federal government to buy insurance.
In June, the Supreme Court ruled in King v. Burwell that ACA tax credit subsidies apply even in states that have not established their own insurance-purchasing exchanges. Our state’s objective never was to take away the tax credit subsidies residents use to defray costs of purchasing insurance.
The upshot of King is the Supreme Court in effect extended the employer mandate to non-exchange states such as Indiana. Now the question is whether the Constitution permits imposing employer-mandate tax penalties on government employers such as states, municipalities and schools. The IRS takes the position they are not exempt.
Our Constitution’s federalism principles restrain state and federal governments from encroaching on each other’s respective authority. One mutual restraint is intergovernmental tax immunity which precludes the federal government from taxing states and vice versa.
As Chief Justice John Marshall wrote in McCulloch v. Maryland in 1819, “The power to tax involves the power to destroy.” The ACA employer mandate is not like ordinary payroll withholding, where state agencies collect and remit federal taxes on behalf of their state employees. We argue the mandate violates the constitutional restriction against direct taxes on states.
This is no minor burden. The employer mandate classifies workers as “full-time” even if they work only 30 hours per week. If even one part-time worker were inadvertently misclassified for benefits under the 30-hour rule, state government would face an IRS tax penalty of $2,000 for every worker in the organization, not just the one or the few triggering the penalty. Indiana has approximately 28,000 executive branch employees, so the potential tax penalty would be approximately $56 million.
This intrusion upon state government’s personnel policies already forced the state to reduce the hours of part-time employees to prevent incurring the penalty. Public schools that rely heavily on part-time cafeteria workers, bus drivers, substitute teachers and coaches also have reduced hours for such workers to avoid massive tax penalties that would be borne by taxpayers. We are pursuing litigation to have the tax declared inapplicable to state and local governments and schools; and our lawsuit filed in 2013 will continue.
Concern over federal taxation of state and local governments should be bipartisan: If the mandate against government employers goes unchallenged, a future Congress or president of either party could impose other new taxes against states, cities or schools to force compliance with a new initiative.
Rather than wait for a crippling tax penalty that would force the Legislature into a difficult budgeting position, the state and 39 schools acted to bring this question to federal court for a decision, and there is no reason to dismiss our lawsuit now.
Critics who scoff at the Indiana v. IRS lawsuit mischaracterize the effort as politically driven by policy disagreements with the ACA; but that is not the role of the attorney general and not the reason my office and 39 schools are pursuing an answer on an issue of significant legal importance.
Critics who now ignore the risks of not litigating would be the first to complain if the state and schools were hit with multimillion-dollar employer-mandate tax penalties. Pursuing an answer from the court –- which we have undertaken at reasonable cost –- is the responsible course for the state, schools and ultimately the taxpayers we serve.