Cities, states warn of credit impact from proposed federal grant rule

Daniel Heuer/Bloomberg

Cities, states, hospitals, universities and other public entities that depend on federal grant funds have until Monday to comment on a proposed Trump administration overhaul of the grant process that critics say carry sweeping implications for the future of federal funds.

The Office of Management and Budget on May 29 published a proposed rule that would revamp the way grants, cooperative agreement and pass-through awards are designed, awarded, administered, and audited across all federal agencies.

The rule would require agencies to appoint a senior political appointee who would approve grants; expand agencies' authority to terminate or suspend active grants that have already been awarded; and restrict grants to recipients that don't adapt to executive orders or have a "history of questionable practices," among other changes.

The National League of Cities is urging its members to file comment letters and plans to file its letter soon, said a spokesperson. The rule would hurt local governments by increasing administrative burdens, creating greater uncertainty around grants, and "further politicize federal grantmaking by introducing broader political considerations into funding decisions," the spokesperson said in an email.

"NLC is particularly concerned about the impact on long-term infrastructure and housing projects," the group said. "If funding is withdrawn midway through construction, communities could be left with unfinished projects while taxpayers shoulder unexpected costs."

The proposal does not affect formula funds, block grants or post-disaster funds, Moody's Investors Service said in a June report that also warned the move could be a credit negative for public entities.

As of Wednesday, the department had received 93,209 comments on the proposal. The Government Finance Officers Association will likely submit its letter Friday, said GFOA federal liaison Emily Brock.

If finalized, the rule would take effect October 1, which would make the final rule applicable to all new fiscal 2027 awards.

"It's all very fast," said Brock, who highlighted the issue to the GFOA's debt committee at its June 27 meeting. "In our office in D.C., there's a full office conversation that's happening" about the proposal, she said.

"The nexus to credit is that 40% of state expenditure are federal funds — if there is discretionary termination that are large or vast, that could have a significant effect on states and local governments and any recipient of federal funds," she said.

The proposal raises several questions, including about those grants that are supposedly outside the rule's purview and how it may impact earmarks, Brock said.

"There are a lot of questions about applications in very specific ways," she said. "Everyone is asking a lot of questions."  

If the rule becomes law, litigation is likely.

"The proposed rule has vulnerabilities that could prompt litigation if and when it is finalized," said Arnold & Porter in a June 17 blog. "At the threshold, it is not obvious that OMB has the requisite statutory authority to impose binding regulations — rather than guidance — governing federal grantmaking, or at least not statutory authority covering all of the sweeping new procedural and substantive mandates the proposed rule would impose," the firm said.

The finalized rule could also could "face significant challenges under the First Amendment," the firm said.

Lawmakers may try to block the move as well.

House Appropriations Chair Sen. Susan Collins, R-Maine, last week sent a letter to Office of Management and Budget director Russell Vought that asked Russell to extend the comment period by no less than 90 days and "withdraw portions of the rule that would potentially harm small and rural communities and scientific and biomedical research."

Arnold & Porter noted that House Appropriations Committee Ranking Member Rep. Rosa DeLauro, D-Conn., in early June offered an amendment to a fiscal 2027 appropriations bill that would have blocked funding to carry out the proposed rule. The amendment failed to advance but "it remains possible that lawmakers will continue to explore legislative avenues, including the ongoing appropriations process, to address the proposed rule," the law firm said.

"It's increasingly becoming partisan on the Hill but ultimately I think this nexus to credit and the larger economic impacts could bring some more bipartisan thinking to these changes," GFOA senior policy advisor Paige Mellerio told the GFOA debt committee.