Can a municipality use ARP funds on operational costs and capital improvements to facilities impacted by lost revenue from pandemic which, prior to COVID-19, generated their own revenue?

Under the Coronavirus State and Local Fiscal Recovery Funds (“CSLFRF”) established by the American Rescue Plan Act of 2021 (“ARP”), municipalities have broad, but not unlimited, discretion to allocate the resources provided to them. Operational costs at facilities that qualify for CSLFRF assistance are eligible costs for CSLFRF funding through December 31, 2024, if the operational costs fall under one of the four eligible uses categories listed below. One of those categories indicates that most “government services,” including operational costs for a component that generates its own revenue, are eligible to the extent of reduction in revenue due to the pandemic, with some exceptions. The three other categories require that expenditures meet separate specific eligibility requirements. Treasury expanded the eligibility of capital expenditures with the issuance of its Final Rule, as discussed in further detail below.

Subsection 603(c)(1) of the Social Security Act (which was enacted pursuant to section 9901 of the ARP and applies to local governments), allows CSLFRF assistance to be used as follows: 

(1) USE OF FUNDS.—Subject to paragraph (2), and except as provided in paragraphs (3) and (4), a metropolitan city, nonentitlement unit of local government, or county shall only use the funds provided under a payment made under this section to cover costs incurred by the metropolitan city, nonentitlement unit of local government, or county, by December 31, 2024— 

(A) to respond to the public health emergency with respect to the Coronavirus Disease 2019 (COVID–19) or its negative economic impacts, including assistance to households, small businesses, and nonprofits, or aid to impacted industries such as tourism, travel, and hospitality; 

(B) to respond to workers performing essential work during the COVID–19 public health emergency by providing premium pay to eligible workers of the metropolitan city, nonentitlement unit of local government, or county that are performing such essential work, or by providing grants to eligible employers that have eligible workers who perform essential work; 

(C) for the provision of government services to the extent of the reduction in revenue of such metropolitan city, nonentitlement unit of local government, or county due to the COVID–19 public health emergency relative to revenues collected in the most recent full fiscal year of the metropolitan city, nonentitlement unit of local government, or county prior to the emergency; or 

(D) to make necessary investments in water, sewer, or broadband infrastructure.[1] 

The permissible uses outlined in the ARP provide municipalities with different options to support impacted industries and critical segments of the local economy whether they are owned and operated by the private sector or a government entity. On January 6, 2022, the U.S. Department of the Treasury (“Treasury”) published its Final Rule relating to the CSLFRF.^[2] The Supplementary Information that accompanies the Final Rule outlines some of the uses of CSLFRF assistance as follows:

The interim final rule expressly permitted use of funds for a limited number of capital expenditures that mostly pertained to COVID-19 prevention and mitigation. These included capital investments in public facilities to meet pandemic operational needs, such as physical plant improvements to public hospitals and health clinics; adaptations to public buildings to implement COVID-19 mitigation tactics; ventilation improvements in congregate settings, health care settings, or other key locations; assistance to small businesses and nonprofits and aid to impacted industries to implement COVID-19 prevention or mitigation tactics, such as physical plant changes to enable social distancing. For disproportionately impacted populations and communities, the interim final rule also expressly permitted development of affordable housing to increase the supply of affordable and high-quality living units.[3]

Treasury also states in the Final Rule’s Supplementary Information discussion:

Capital expenditures, in certain cases, can be appropriate responses to the public health and economic impacts of the pandemic, in addition to programs and services. Like other eligible uses of SLFRF funds in this category, capital expenditures should be a related and reasonably proportional response to a public health or negative economic impact of the pandemic. The final rule clarifies and expands how SLFRF funds may be used for certain capital expenditures, including criteria and documentation requirements specified in this section, as applicable.[4]

The Final Rule’s Supplementary Information Discussion elaborates on capital expenditure eligibility as follows:

Treasury provides presumptions and guidelines for capital expenditures that are enumerated earlier in sections Public Health, Negative Economic Impacts, and General Provisions: Other under the Public Health and Negative Economic Impact eligible use category (“enumerated projects”), along with capital expenditures beyond those enumerated by Treasury. In addition to satisfying the two-part framework in Standards: Designating a Public Health Impact and Standards: Designating a Negative Economic Impact for identifying and designing a response to a pandemic harm, Treasury will require projects with total expected capital expenditure costs of $1 million or greater to undergo additional analysis to justify their capital expenditure. Increased reporting requirements will be required for projects that are larger in size, as well as projects that are not enumerated as eligible by Treasury, with certain exceptions for Tribal governments discussed below. Smaller projects with total expected capital expenditures below $1 million will not be required to undergo additional analysis to justify their capital expenditure, as such projects will be presumed to be reasonably proportional, provided that they are responding to a harm caused or exacerbated by the public health emergency…[5]

In addition, Treasury describes the process of reporting on capital expenditures as follows:

As with all uses, recipients that undertake capital expenditures beyond those enumerated as eligible by Treasury must meet the two-part framework under Standards: Designating a Public Health Impact and Standards: Designating a Negative Economic Impact under General Provisions: Structure and Standards, including the requirement that responses are related and reasonably proportional to the harm or impact identified. As part of that assessment, these recipients may also be asked to complete a Written Justification. Recipients (other than Tribal governments) are subject to the following presumptions for the Written Justification of the capital expenditure, based on the total expected capital expenditures of the project:

• Projects with total expected capital expenditures of under $1 million: Treasury provides a safe harbor for unenumerated projects with total expected capital expenditures of under $1 million and will not require recipients to complete, submit, or meet the substantive requirements of a Written Justification of the capital expenditure. Recipients should still make a determination as to whether the capital expenditure is part of a response that is related and reasonably proportional to the public health emergency or its negative economic impacts.
• Projects with total expected capital expenditures of $1 million or over: Recipients should complete a Written Justification of the capital expenditure and make an independent assessment that their proposed capital expenditure meets the substantive requirements of the Written Justification. Further, recipients will be asked to submit the Written Justification as part of regular reporting to Treasury.

Treasury employs a risk-based approach to overall program management and monitoring, which may result in heightened scrutiny on larger projects. Accordingly, recipients pursuing projects with larger capital expenditures should complete more detailed analyses for their Written Justification, commensurate with the scale of the project.[6]

Treasury also requires that the written justification on capital expenditures of $10 million or greater be included in the recipient’s regular reporting to Treasury.[7]

Finally, it is noteworthy that Treasury describes the background relating to the use of CSLFRF assistance for capital improvements as follows:

In the interim final rule, Treasury noted that a “general infrastructure project, for example, typically would not be included [in this eligible use category] unless the project responded to a specific pandemic public health need.” Numerous commenters requested that Treasury permit investments in infrastructure as a response to the public health and negative economic impacts of the pandemic…. In the final rule, Treasury is maintaining the approach under the interim final rule that general infrastructure projects, including roads, streets, and surface transportation infrastructure, would generally not be eligible, unless the project responded to a specific pandemic public health need or a specific negative economic impact. Note, however, that Treasury has clarified that capital expenditures that are related and reasonably proportional to responding to the public health and economic impacts of the pandemic are eligible uses of funds….[8]

Treasury describes its rationale for this approach as follows:

In the interim final rule, Treasury permitted funds to be used for a limited number of capital expenditures mostly related to the COVID-19 public health response. This decision granted recipients some discretion to use [CSLFRF] funds to address COVID-19 prevention and mitigation through certain investments in equipment, real property, and facilities, which Treasury recognized as critical components of the public health response. In the final rule, Treasury considered maintaining the provisions in the interim final rule or expanding allowable capital expenditures to provide recipients greater flexibility to pursue other capital investments that are responsive to the public health emergency and its negative economic impacts. While expanding allowable capital expenditures may increase the risk that recipients will undertake large expenditures that do not sufficiently address intended harms, or address harms in a less cost-efficient manner than an alternative investment (e.g., a program or service), expanding allowable capital expenditures would likely help fill critical gaps in recipients’ response to the pandemic and provide equipment and facilities that generate benefits beyond SLFRF’s period of performance. To preserve flexibility while mitigating risks, the final rule allows recipients to undertake an expanded set of capital expenditures while requiring additional written justifications for projects with an expected total cost at or over $1 million. Treasury believes this approach balances the implementation of appropriate risk-based compliance requirements and the provision of administrative convenience for smaller capital expenditures, while generally allowing recipients the flexibility to undertake a greater variety of responsive capital expenditures.[9]

An overview of the capital expenditure requirements can be found in the Final Rule between pages 190 through 205. A succinct overview of these requirements can also be found in Coronavirus State & Local Fiscal Recovery Funds: Overview of the Final Rule between pages 30 through 31.[10]

Last Revised: February 24, 2022