Repealing contract withholding tax would encourage tax evasion

Senator Reid plans to rewrite a House-passed measure repealing a rule that governments withhold 3 percent of payments to contractors starting in 2013. Read more here.

Center on Budget and Policy Priorities recently released a short report arguing that repealing the contractor withholding provision would encourage tax evasion among contractors the 2006 law signed by President Bush meant to eliminate. Repealing the law would reduce revenues by around $600 to $700 million a year because of increased tax abuse, based on estimates from the Joint Committee on Taxation ("JCT").

In response, the JCT recommended in 2005 that Congress impose a withholding requirement — one of the most common and effective methods of improving tax compliance — on government contractors. The 2006 law, scheduled to take effect in 2013, imposes a 3 percent withholding requirement on contractors in order to allow the federal government to collect taxes that contractors would already owe. The IRS has exempted contract payments worth less than $10,000.

GAO Has Uncovered Serious Tax Abuse by Government Contractors
GAO has found in multiple studies that thousands of federal contractors abuse the tax system each year. For example, in 2007 GAO summarized several of its previous reports, stating that 27,000 DOD contractors, 33,000 civilian agency contractors, and 3,800 GSA contractors owed about $3 billion, $3.3 billion, and $1.4 billion in unpaid taxes, respectively.[8] Earlier this year, GAO found that 3,700 contract and grant recipients of Recovery Act funds owed $750 million in unpaid taxes.

Tax abuse and non-payment of tax debts by federal contractors result in higher deficits, larger spending cuts, or an increased tax burden on taxpayers who meet their legal obligations. They also can hurt tax-compliant federal contractors, who may lose out on contracts because tax evaders and non-payers can undercut them on price as a result of illegal tax-evasion and abusive behavior. The GAO has identified instances in which contractors with tax debts won awards based on a price differential over tax-complaint contractors.

Repeal would encourage tax abuse, while sending a signal to honest taxpayers that they will have to pick up more than their fair share for the cost of government.