Tax withholding provision sparks uproar among contractors
Language slipped into tax cut package would require government to withhold 3 percent from payments for many goods and services.
Local government groups and contractors are pledging to fight to roll back a provision quietly added to the tax reconciliation conference report that would take the unprecedented step of withholding taxes from payments made to federal, state and local contractors.
The provision -- which could affect a wide range of contracts from multibillion dollar defense contracts right down to garbage collection services procured by city and county governments -- would pose an enormous administrative burden on contractors and on governments, the groups said.
Under the provision, federal, state and local governments would be required to withhold 3 percent from payments for many kinds of goods and services.
Tax-writers delayed the effective date of the provision until 2011, which gives local and state governments time to prepare for the implementation of the withholding requirement. The delay also might create a legislative battleground as opponents fight to repeal the requirement or scale it back.
"We expect this to pass the Senate, and then the scramble begins," said Alysoun McLaughlin, associate legislative director at the National Association of Counties.
"If we can't get it repealed immediately, we'll talk to Treasury to figure out how this is going to work, look at how it would affect procurement, and figure out if we can make something work. In the meantime, we'll keep fighting," she said.
Sen. Larry Craig, R-Idaho, speaking on the floor Thursday before the Senate voted 54-44 to send the tax-cut package to the president, called the withholding requirement "misleading" and "the wrong thing to do. ... I'm going to vote for this bill, but I'm going to work every day after I vote to have this out before 2010," said Craig.
Opponents had little time to fight the provision because it was slipped into the conference report without having been included in either the House- or Senate-passed tax reconciliation bills.
The provision is scored to raise $7 billion between 2011 and 2015, and tax committee staff closely guarded their revenue raisers before bill details were announced Tuesday evening.
Local government representatives rushed to the ramparts, warning senators to vote against the tax package.
In a Wednesday letter, NACO, the National League of Cities and the Government Finance Officers Association called the provision "egregious" and said it would "put counties and cities at a severe competitive disadvantage to the private sector in purchasing goods and services."
Had the proposal seen the light of day earlier, critics might have been able to fight it substantively and procedurally.
The Congressional Budget Office said in a Tuesday analysis that the withholding provision would impose an unfunded mandate on state and local governments, and would exceed allowable thresholds in the federal unfunded mandates law.
The provision was one of a host of proposals offered by the Joint Committee on Taxation in 2004 as options for improving tax compliance, or narrowing the so-called tax gap.
The Government Accountability Office has also highlighted the problem of underpayment of taxes by federal contractors, finding in a February 2004 report that in 2002, Defense Department contractors owed $3 billion in unpaid federal taxes.
The withholding provision is also supported by Democrats, and was included as a revenue raiser in the Democratic substitute to the Senate tax reconciliation bill.
Aides argued that the provision would aid state and local governments by helping them collect taxes that otherwise would go unpaid. "Withholding is the least intrusive, most cost-effective way to ensure compliance," said one Finance Committee aide.
Patrick McCartan, director of legislative affairs at the Aerospace Industries Association, said most prime defense contractors now make lump sum quarterly federal tax payments.
The new withholding system would appear to force firms to track tax liability on a payment-by-payment basis. "This is a compliance and reporting nightmare for law-abiding taxpayers," he said.
But critics added that until they have fully analyzed the provision, they will not know its full scope.
The provision will not apply to contracts for public assistance and welfare programs, and local governments with less than $100 million in annual expenditures will also be exempt.