The Obama administration is suing the state of North Carolina over its so-called bathroom bill, saying it breaks federal anti-discrimination laws.
The law requires transgender people to use bathrooms that correspond to their sex at birth instead of the gender with which they identify.
U.S. Attorney General Loretta Lynch on Monday called the North Carolina law "state-sponsored discrimination" that reminds her of a time when blacks were barred from public facilities and states could dictate who was allowed to marry.
The federal government has named the state, its Republican Governor Pat McCrory, the Department of Public Safety, and the University of North Carolina — which receives millions in federal funds — in the lawsuit.
"This is about the dignity and respect we accord our fellow citizens," Lynch said, stressing that the law has caused "emotional harm, mental anguish, distress, humiliation and indignity" to transgender people.
Earlier Monday, North Carolina sued the federal government to keep the law in place.
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McCrory said Washington is "being a bully ... trying to define gender identity, and there is no clear identification or definition of gender identity."
McCrory and other supporters of the measure defend it as necessary to protect privacy in public bathrooms and guard against men using women's restrooms to spy and prey on women.
Lynch said the state invented a problem that does not exist as an excuse to discriminate and harass people.
In addition to possibly losing federal funds, North Carolina could also lose hundreds of millions of dollars in tax revenue from businesses that are canceling plans to open offices in the state.
Rock stars Bruce Springsteen and Nick Jonas and the bands Pearl Jam and Boston have backed out of concerts they planned for North Carolina. Both Pay Pal, a funds transfer company, and Deutsche Bank canceled plans to expand into the state.
A new CNN/ORC poll Monday shows 57 percent of Americans oppose such laws — bad news for a state that looks forward to thousands of tourists spending their summer vacations at North Carolina beaches.
While the North Carolina law was enacted by Republicans over the opposition of state Democratic lawmakers, Donald Trump, the presumptive Republican presidential candidate, says he does not think the law is necessary.
"There have been very few complaints the way it is," Trump told one interviewer last month. "People go, they use the bathroom that they feel is appropriate. There has been so little trouble, and the problem with what happened in North Carolina is the strife and the economic punishment that they're taking."
Trump invited the country's most public transgender person, Caitlyn Jenner, who as a man won an Olympic gold medal, to use whatever restroom she wanted at one of his New York skyscrapers.
Jenner used a women's bathroom and made a point of announcing afterward that she had not been molested while doing so.
WATCH: North Carolina's Bathroom Law Under Scrutiny