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House Punts on Tax Cheating by Government Contractors

The House voted today to repeal a law designed to fight tax cheating by private firms operating under government contracts.  Now it’s up to the Senate to decide whether to go along with the House and ignore this problem, which increases deficits and forces honest taxpayers to pay for more than their fair share of government.

Here’s the story, outlined in our new report:

During the George W. Bush Administration, Government Accountability Office investigations found that “thousands of federal contractors had substantial amounts of unpaid federal taxes” totaling in the billions of dollars.

Congress’ Joint Tax Committee recommended that policymakers address the problem through a withholding requirement, one of the most common and effective ways to improve tax compliance.  Most households are familiar with tax withholding, since employers withhold income and payroll taxes on employees’ wages.

In 2006, President Bush and Congress enacted a measure that imposed a 3 percent flat withholding rate on contracts that firms have with federal, state, or local governments.  If, at the end of the tax year, the contractor’s final federal tax liability turns out to be greater or smaller than the amount withheld, the contractor pays the difference or receives it in the form of a refund.

So far, so good.

However, contractors lobbied heavily against the new law, arguing that it would impose an oppressive burden on them.  Policymakers delayed implementation of the law from 2011 to 2013 and made several changes to respond to contractors’ concerns, like exempting contracts worth less than $10,000.

The House has now voted to repeal the provision and the Obama Administration has thrown its weight behind the legislation, concluding that repeal “would reduce a burden on government contractors who otherwise comply with their tax obligations, particularly small businesses.”  But repeal does nothing about the thousands of contractors that GAO has shown don’t pay their taxes.

The repeal measure now goes to the Senate.  Fortunately, at least one key member of that body, Senator Grassley (R-IA), has kept his eye on the important issue at stake; Grassley told a Bloomberg interviewer that “he didn’t want to end the [withholding] requirement without addressing the issue of tax cheating by contractors.”  The Senate should reject repeal or, if it does repeal the provision, put in an alternative that addresses the underlying problem.

Chuck Marr
Vice President for Federal Tax Policy