WITHHOLDING TAXES: TOO TAXING ON GOVERNMENT PROCUREMENT

WITHHOLDING TAXES: TOO TAXING ON GOVERNMENT PROCUREMENTAuthor(s): Rebecca PereiraSource: Public Contract Law Journal, Vol. 38, No. 2 (Winter 2009), pp. 451-468Published by: American Bar AssociationStable URL: http://www.jstor.org/stable/25755716 .

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WITHHOLDING TAXES: TOO TAXING ON GOVERNMENT PROCUREMENT

Rebecca Pereira

I. Introduction. 452 II. Brief History of the Use of Collateral Socioeconomic

Policies in the American Government Procurement System. 452

III. Collateral Tax Policies. 453 A. Currently Enforced Collateral Tax Policies. 453 B. Proposals for Additional Collateral

Tax Policies. 455 IV. GAO's Estimate of Federal Contractors'

Tax Debts. 457 V. The Tax Increase Prevention and Reconciliation

Act of 2005, Section 511. 458 VI. Cost-Benefit Analysis of Section 511. 461

A. Benefits. 461 B. Costs. 463

VII. Detailed Analysis of Section 511. 465 A. Why Should Agencies Pay for the Failure of the IRS

to Collect Taxes?. 465 B. Why Will This Program Be More Efficient

Than Previous Attempts by the IRS to Use the Government Procurement

System to Collect Taxes?. 465 C. Why Is the Withholding Applied Against

Government Contractors and Not

Payments Made to All Independent Contractors?. 466 D. Implementation Against State and

Local Entities. 466 E. Cumulative Effects of Collateral

Socioeconomic Policies. 467

F. Solution Through Amending Section 511?. 467

VIH. Conclusion. 468

Rebecca Pereira ([email protected]) is a third-year law student at The George Wash

ington University Law School. She serves as a Notes Editor for the Public Contract Law

Journal.

451



452 Public Contract Law Journal Vol. 38, No. 2 Winter 2009

I. INTRODUCTION

"Withholding is the ultimate hidden tax. When taxpayers no lon

ger see the money that is withheld from their paychecks, the cost of government becomes obscured. And with government spending what it is right now, transparency is what we need."1

?Senator Craig (R-Idaho)

Although withholding is not technically a hidden tax2 and does not increase tax rates, Senator Craig's statements represent the belief that the imposition of

withholding upon government payments would be a tax on both government

agencies and contractors because it would increase costs and reduce competi tion. Section 511 of the Tax Increase Prevention and Reconciliation Act of

2005 (TIPRA) is used in this Note as a case study to demonstrate the ineffi

ciencies of the use of collateral socioeconomic policies in the federal govern ment procurement system.3 These policies have subverted some of the main

goals of the government procurement system including receiving the best

value, efficiency, and transparency,4 and their use should be limited wherever

possible. Specifically, section 511 of TIPRA, which requires government agen cies to withhold 3% of payments made to government contractors,5 should be

repealed because the costs of implementing the policy far outweigh the poten tial benefits of lessening the tax gap.6

First, this Note will give a brief history of attempts by the Internal Revenue

Service (IRS) to impose collateral tax policies on federal agencies. Next, this Note will discuss how the failure of these policies led to the drafting of section 511 of TIPRA. Finally, this Note will conduct a cost-benefit analysis of section

511, offering recommendations as to how the negative effects can be limited.

II. BRIEF HISTORY OF THE USE OF COLLATERAL SOCIOECONOMIC POLICIES IN THE AMERICAN

GOVERNMENT PROCUREMENT SYSTEM

The Federal Government has not limited the use of the procurement sys tem for mere efficient and inexpensive procurement of goods and services,

1. 152 Cong. Rec. S4385, S4422 (daily ed. May 11, 2006). 2. Although taxes themselves are not increased by withholding, one could argue that with

holding does create an additional tax burden because of the time value of money, as discussed

infra Part VIA 3. See Tax Increase Prevention and Reconciliation Act of 2005, Pub. L. No. 109-222, ? 511,

120 Stat. 345, 364-65 (2006) (to be codified at 26 U.S.C. ? 3402(t)). 4. See Steven L. Schooner, Desiderata: Objectives for a System of Government Contract Law, 11

Pub. Procurement L. Rev. 103, 103 (2002). 5. See Tax Increase Prevention and Reconciliation Act ?511. 6. The tax gap is an indicator used by the Internal Revenue Service (IRS) to measure taxpayer

compliance with filing tax returns and paying taxes on time. The tax gap is caused by the non

filing of tax returns, underreporting of income, and underpayment of taxes due. In short, the tax gap is the difference between the amount of taxes that should be paid and the taxes that are



Tax Increase Prevention & Reconciliation Act of2005 Section 511 453

but instead has used it to effectuate collateral policies that could not other wise be implemented in the private sector. Among these collateral polices are small business set asides, preferences for disadvantaged business owners, domestic preference policies, and labor standards.7 The Government has been able to implement these policies because of its special commercial re

lationship with government contractors. However, many large corporations are government contractors,8 effectively making these policies enforceable

against the majority of large businesses. These policies place additional burdens on government agencies during procurement and often conflict with both each other and the main goals of a successful federal procure ment system. In recent years, several of these collateral policies have been

proposed.

III. COLLATERAL TAX POLICIES

A. Currently Enforced Collateral Tax Policies

The following description of past collateral tax policies, including the im

position of withholding taxes, demonstrates how these collateral policies are still being implemented today, how ineffective they are, and how they inter fere with procurement by government agencies.

Since the early 1990s there has been concern over government contrac tors' failure to comply with tax laws coupled with several attempts of the IRS to collect the back taxes through federal agencies.9 The Department of

Treasury, with the assistance of government agencies, has created several sys tems to ensure greater compliance with the tax laws.10 One of these systems is the Debt Collection Improvement Act of 1996 (DCIA).11 The DCIA re

quires government agencies to compare current contractors with names on

the Treasury Offset Program (TOP) database, which lists government con tractors with tax delinquencies.12 If there is a match with a name on the TOP,

actually paid on time. Internal Revenue Serv., Tax Gap Facts and Figures 1 (2005), available at

http://www.irs.gov/pub/irs-utl/tax_gap_facts-figures.pdf. 7. See, e.g., Small Business Act, 15 U.S.C. ?? 637(a), 644 (2006); Davis-Bacon Act, 40 U.S.C.

? 276a (2000); Buy American Act, 41 U.S.C. ?? lOa-lOd (2000). 8. See, e.g., Top 200 Federal Contractors, Gov't Executive, Aug. 15, 2004, available at http://

www.govexec.com/features/0804-15/0804-15s 1 s 1 .htm. 9. U.S. Gen. Accounting Office, Financial Management: Some DoD Contractors

Abuse the Federal Tax System with Little Consequence 3-6 (2004) [hereinafter Some DoD Contractors Abuse the Federal Tax System with Little Consequence]; U.S. Gov't Accountability Office, Thousands of Federal Contractors Abuse the Federal Tax System 1 (2007) [hereinafter Thousands of Federal Contractors Abuse the Federal Tax System].

10. See, e.g., Some DoD Contractors Abuse the Federal Tax System with Little

Consequence, supra note 9, at 3-6. 11. Debt Collection Improvement Act of 1996, Pub. L. No. 104-134, ? 31001, 110 Stat.

1321, 1321-358 to 381 (codified in scattered sections of 26 U.S.C, 28 U.S.C, 31 U.S.C, and 42 U.S.C).

12. Some DoD Contractors Abuse the Federal Tax System with Little Consequence,

supra note 9, at 11.




the federal payment is offset by the debt owed.13 This program is managed by the Financial Management Service of the Treasury Department, the dis

bursing agency for more than 85% of federal payments.14 The TOP also is

used to offset nontax debts owed to the Government including unpaid loans,

overpayments or duplicate payments made to federal salary or benefit pay ment recipients, misused grant funds, and fines, penalties, or fees assessed by government agencies.15 In the past, agencies have failed to levy a significant portion of these unpaid debts.16 This failure was partially due to the limita tions the Department of Treasury placed on payments that were to be offset, and partially due to the failure of agencies to report payments to the TOP.17 In

February 2004, the Government Accountability Office (GAO)18 reported that the Defense Finance and Accounting Service (DFAS), the accounting agency of the Department of Defense (DoD), had previously failed to and had no

plans to report payments made to its top fifteen vendors.19 The Federal Payment Levy Program (FPLP), authorized by the Taxpayer

Relief Act of 1997, was another attempt to recoup unpaid taxes from govern ment contractors.20 The FPLP permits the IRS to levy 15% of federal pay ments made to delinquent taxpayers.21 The levy is implemented continuously until the tax debt is fully repaid, at which point the IRS releases it.22 The IRS imposes restrictions on which contractors are involved in the program and places additional restrictions on those who are in the program,23 thus

13. Dep't of the Treasury, Fin. Mgmt. Serv., Fact Sheets, http://www.fms.treas.gov/news/ factsheets/dcia.html.

14. Id. 15. Id. 16. Some DoD Contractors Abuse the Federal Tax System with Little Consequence,

supra note 9, at 19. 17. Id. at 22. The limitations that the Treasury Department placed on payments that were

to be offset or levied is discussed infra note 23, in the discussion of the failure of the Federal

Payment Levy Program. 18. At the time, the GAO was known as the General Accounting Office. The GAO officially

changed its name to the Government Accountability Office on July 7, 2004. 19. Some DoD Contractors Abuse the Federal Tax System with Little Consequence,

supra note 9, at 19. 20. Taxpayer Relief Act of 1997, 26 U.S.C. ? 6331 (2000). 21. U.S. Gen. Accounting Office, Tax Administration: Federal Payment Levy Program

Measures, Performance, and Equity Can Be Improved 1 (2003), available at http://www. gao.gov/new.items/d03356.pdf [hereinafter Federal Payment Levy Program Measures, Performance, and Equity Can Be Improved].

22. Mat2. 23. The IRS excludes cases from being placed in the levy program when they are in certain

phases of collection, including when the taxpayer is notified of unpaid taxes, when the debt is

placed in the Automatic Collection System (ACS), when the case is awaiting assignment to a col lection officer, and when the case is assigned to a field collection officer. Some DOD Contractors

Abuse the Federal Tax System with Little Consequence, supra note 9, at 22-23. Placement in the levy program is subordinated to these other collection efforts, which can take many years to complete. Id. The IRS also excludes cases from the levy program for events such as bankruptcy, litigation, financial hardship, and the application for an installment agreement or compromise.

Mat 25.




thwarting its ability to recover on hundreds of millions of dollars in tax debt.24 These restrictions were enacted partially due to the IRS's lack of resources and the fear that the increased collection would disrupt normal collection

procedures.25

B. Proposals for Additional Collateral Tax Policies

Congress has also attempted to implement tax policies directly by amend

ing the Federal Acquisition Regulation (FAR). In 1992, the GAO recom mended that compliance with the tax laws be a prerequisite for obtaining a

government contract.26 Later in 2000, the 106th Congress considered H.R.

4181, which prohibited contractors with tax delinquencies from being eli

gible to receive federal government contracts as well as federal loans.27 At the time of this debate, the IRS was unable to provide federal agencies with

complete and accurate data regarding the tax delinquencies of contractors.28 The GAO conjectured that this new program would cause significant admin istrative burdens in both cost and time, which could not be decreased until the IRS and government agencies modernized their systems to allow for ef ficient reporting of tax delinquencies.29 The GAO further recommended that

Congress amend the proposed bill to allow contractors to remain eligible for

government contracts if they were willing to discuss payment with the IRS.30 This bill did not become a law and is no longer up for consideration, as it was introduced in a previous session of Congress.

An existing requirement for government contractors is a finding of respon

sibility.31 The current requirements for responsibility include that a prospec tive contractor "have a satisfactory record of integrity and business ethics."32 A "satisfactory record of integrity and business ethics" has not been interpreted

24. See Federal Payment Levy Program Measures, Performance, and Equity Can Be

Improved, supra note 21, at 3. 25. The inability of the IRS to collect payments and manage the current federal tax system

is evidenced not only by its failure to collect taxes from government contractors, but also by its failure to collect from individuals. In 2006, the IRS began contracting out tax collection to

private collection agencies to collect smaller tax debts, even though the privatization was known to cost more. See American Jobs Creation Act of 2004, Pub. L. No. 108-357, ? 881, 118 Stat.

1418, 1625-27. See generally Emily Rockwood, Note, Privatizing Tax Collection: A Case Study in

the Outsourcing Debate, 36 Pub. Cont. L.J. 423 (2007). 26. See U.S. Gen. Accounting Office, Debt Collection: Barring Delinquent Taxpayers

from Receiving Federal Contracts and Loan Assistance 1 (2000) (testimony) [hereinafter Barring Delinquent Taxpayers from Receiving Federal Contracts and Loan Assistance].

27. See id. at 3; H.R. 4181, 106th Cong. (2004). 28. Barring Delinquent Taxpayers from Receiving Federal Contracts and Loan

Assistance, supra note 26, at 5. 29. These concerns over administrative burdens are similar to those that exist today over sec

tion 511 of TIPRA. See Barring Delinquent Taxpayers from Receiving Federal Contracts and Loan Assistance, supra note 26, at 6.

30. See id. at 10. 31. FAR9.103. 32. FAR9.104-l(d).




to require a contractor's compliance with tax laws.33 However, a contractor

can be suspended or debarred for suspicion or conviction of tax evasion.34 In December of 2000, a revision to the FAR35 required Contracting Officers

(COs) to consider a prospective contractor's compliance with tax laws when

determining responsibility.36 This rule was finalized and published despite concern that it would have a disparate effect on small businesses because of their lack of resources to contest a finding of nonresponsibility.37 In response to a lawsuit brought in the District Court for the District of Columbia seek

ing an overturn of the rule, the FAR Council stayed the final rule to reassess

its burdens and advantages.38 The revision was finally repealed in December

2001,39 effectively allowing tax-delinquent contractors to remain eligible to

receive government contracts.

However, on November 16, 2007, Senator Coleman of Minnesota intro duced S. 2394, calling for a similar amendment to the FAR requiring govern ment contractors to be free of tax debt.40 The bill, the Good Government Contractor Act of 2007, if passed, would have required the Department of

Treasury to maintain a national federal tax registry and would require COs to access the registry when making a determination of responsibility.41 Under the Good Government Contractor Act, tax debt is defined as an outstanding debt due pursuant to the Internal Revenue Code (I.R.C.) that has not been

paid within 180 days of assessment, which is not subject to further appeal or

petition.42 The Good Government Contractor Act also called for amendment of the FAR to provide that a tax debt, as defined above, be a cause for debar

ment or suspension.43

Additionally in March 2007, the Civilian Agency Acquisition Council and the Defense Acquisition Regulations Council proposed to amend the FAR to

require contractors to certify (1) whether they have been convicted of or had a civil judgment issued against them for failure to pay taxes or violating any tax law or (2) whether they have been notified of any tax delinquency in the three

33. Some DoD Contractors Abuse the Federal Tax System with Little Consequence, supra note 9, at 42-43.

34. FAR 9.406-2(a)(3). 35. See FAR Case 1999-010, Contractor Responsibility, Labor Relations Costs, and Costs

Related to Other Legal Proceedings, 65 Fed. Reg. 80,256, 80,256 (Dec. 20, 2000). 36. Some DoD Contractors Abuse the Federal Tax System with Little Consequence,

supra note 9, at 43 & n.67. 37. FAR Case 1999-010, 65 Fed. Reg. at 80,261. 38. FAR Case 1999-010, Contractor Responsibility, Labor Relations Costs, and Costs Relating

to Legal and Other Proceedings, 66 Fed. Reg. 17,754, 17,754-55 (Apr. 3, 2001). 39. FAR Case 1999-010, Contractor Responsibility, Labor Relations Costs, and Costs Relating

to Legal and Other Proceedings, 66 Fed. Reg. 66,984, 66,984-86, 66,987 (Dec. 27, 2001); see Some DOD Contractors Abuse the Federal Tax System with Little Consequence, supra note 9, at 43 n.67.

40. S. 2394, 110th Cong. (2007). This bill also called for a repeal of section 511 of TIPRA. Id.

41. Id. 42. Id. 43. Id.




years prior to the offer.44 Their proposal also recommended amending the FAR to make delinquent taxes or tax liens a cause for debarment.45 Currendy, con tractors must certify whether they have been convicted of or have had a civil

judgment issued against them for tax evasion.46 However, COs generally do not have direct access to the IRS's tax data on contractors without contractor con

sent, thus making it difficult to comply with these proposed requirements.47

IV. GAO'S ESTIMATE OF FEDERAL CONTRACTORS' TAX DEBTS

The latest collateral tax policies were proposed in response to the GAO's 2004 report that over 27,000 defense contractors owed $3 billion in back taxes as of 2002.48 Further study by the GAO revealed that 33,000 civilian

agency contractors owed over $3 billion in back taxes and that 3,800 General Services Administration (GSA) contractors owed over $1 billion in back taxes.49 Activity of forty-seven of the studied defense contractors registered in the Central Contractor Registration (CCR) amounted to potential criminal

activity.50 Unpaid taxes included payroll, corporate income, excise, unemploy ment, and individual income, as well as other taxes.51 The majority of these contractors primarily owed back payroll taxes,52 and 52% of the unpaid $3 bil lion in taxes dated back to tax periods before September 30,1999.53 Due to ac

crual of interest and tax penalties, the likelihood of these tax debts being paid decreases with time.54 The GAO also reported that the $3 billion estimate is likely understated due to data integrity issues within the DoD's contrac tor database and the imprecise reporting of Taxpayer Identification Numbers

(TINs), allowing for billions of dollars in payments to escape association with

any potential tax debts.55 Further, section 6502 of the I.R.C. only provides the IRS with ten years from the assessment of such taxes to seek collection (absent

44. FAR Case 2006-011, Representations and Certifications?Tax Delinquency, 72 Fed. Reg. 15,093, 15,093 (proposed Mar. 30, 2007).

45. A*, at 15,094. 46. See FAR 9.408. 47. Thousands of Federal Contractors Abuse the Federal Tax System, supra note 9,

at 3. 48. Some DOD Contractors Abuse the Federal Tax System with Little Consequence,

supra note 9, at 3. 49. Thousands of Federal Contractors Abuse the Federal Tax System, supra note 9, at

1-2. 50. Some DOD Contractors Abuse the Federal Tax System with Little Consequence,

supra note 9, at 4. 51. Id.it 14. 52. Forty-two percent of unpaid taxes were payroll taxes, 39% were unpaid corporate income

taxes, 7% were unpaid excise taxes, 5% were unpaid unemployment taxes, 1% were individual

income taxes, and 5% were other unpaid taxes. Id.

53. Some DOD Contractors Abuse the Federal Tax System with Little Consequence,

supra note 9, at 16. 54. Id. 55. Id. at 17.




timely filing by the IRS of a suit to collect the tax or waiver by the taxpayer of the statute of limitations).56

In early 2005 the Joint Committee on Taxation (JCT) made recommen

dations to improve tax compliance by government contractors and, more

specifically, on how to close the tax gap.57 The JCT recommended that the

Government withhold taxes on payments made by government entities.58 This recommendation was among many others that the JCT believed would

help increase revenue to the Government.59 The tax compliance of taxpayers who are subject to withholding is approximately 99%, while those taxpayers who do not have taxes withheld have a much lower rate of compliance.60 The

JCT's advice to address this problem among government contractors was to

institute a withholding program, to eliminate opportunities for noncompli ance, and to ease the IRS's burden in collecting.61

V THE TAX INCREASE PREVENTION AND RECONCILIATION ACT

OF 2005, SECTION 511

In response to the reports of the GAO and the advice of the JCT, Congress passed TIPRA into law on May 17, 2006.62 Included in TIPRA is a provi sion that follows the recommendations of the JCT, imposing a withholding of taxes on payments made to government contractors. Section 511 of TIPRA

provides in relevant part:

(a) In General. ?Section 3402 is amended by adding at the end the following new subsection:

"(t) Extension of Withholding to Certain Payments Made by Government Entities.?

"(1) General Rule.?The Government of the United States, every State,

every political subdivision thereof, and every instrumentality of the

foregoing (including multi-State agencies) making any payment to any person providing any property or services (including any payment made in connection with a government voucher or certificate program which

functions as a payment for property or services) shall deduct and with hold from such payment a tax in an amount equal to 3 percent of such payment.

"(2) Property and Services Subject to Withholding.?Paragraph (1) shall not apply to any payment...

56. I.R.C. ? 6502 (2000). 57. Joint Committee on Taxation, Options to Improve Tax Compliance and Reform

Tax Expenditures 6 (Jan. 27, 2005), available at http://www.access.gpo.gov/congress/joint/pdf/ 109cp/98128.pdf [hereinafter Joint Comm. on Taxation].

58. Id. 59. Id. at 9. 60. Id. at 6. 61. Id. 62. See Tax Increase Prevention and Reconciliation Act of 2005, Pub. L. No. 109-222, ? 511,

120 Stat. 345, 364-65 (2006).




"(G) made by a political subdivision of a State (or any mstrumentality thereof) which makes less than $100,000,000 of such payments annually_63

This provision requires all federal entities and state government entities that make more than $100 million in payments annually to government contractors to withhold 3 % in taxes from payments made to such contractors beginning

December 31, 2010.64The text of section 511 will be added to section 3402 of the LR.C, which is the section that requires employers to withhold taxes from

wages and certain other payments made to their employees.65 This section does not require businesses to withhold taxes from independent contractors in the private sector because they are not employees.66 Instead of requiring contractors to report all of their income independently when they file their tax

returns,67 section 511 forces government entities to treat contractors similar to their own employees. The taxes withheld by an agency will be forwarded to the IRS and credited against the contractor's current year's tax liability, and will be allowed as a deduction against the tax liability calculated on the contractor's tax return. By requiring agencies to withhold payment as a credit

against contractor tax liability, Congress intends to lessen the tax gap.68 Since TIPRA was passed, section 511 has received great disapproval from

government contractors, the Small Business Administration (SBA), and con

gressmen.69 Such concerns were addressed during debate on the Senate floor.70 Senator Craig of Idaho alleged that the IRS failed to properly do its job and was using this provision to shift responsibility elsewhere.71 Senator Craig also addressed concerns over the ability of small businesses to function when their cash flows are disturbed.72

Several organizations representing government contractors have conveyed their own concerns over how section 511 will affect their ability to conduct business with the Government in the future. A group of over fifty government contractors have banded together to form an organization with the purpose of pushing for the repeal of section 511.73 This organization, the Government

Withholding Relief Coalition (GWRC), has lobbied congressmen and testi fied on Capitol Hill in hopes that action will be taken to prevent the provision

from taking effect.74

63. Id. 64. Id. 65. I.R.C. ? 3402 (2000). 66. Id. 67. See Tax Increase Prevention and Reconciliation Act ?511. 68. See 152 Cong. Rec. S4385, S4422 (daily ed. May 11, 2006) (statement of Sen. Craig). 69. See id.; Government Withholding Relief Coalition, http://www.withholdingrelief.org/

portal/gwrc/default (last visited Nov. 10, 2008). 70. See 152 Cong. Rec S4385, S4422 (daily ed. May 11, 2006) (statement of Sen. Craig). 71. Id. 72. Id. 73. See Government Withholding Relief Coalition, http://www.withholdingrelief.org/portal/

gwrc/default (last visited Nov. 10, 2008). 74. Id.




The SBA also has expressed concern, showing support for legislation to

repeal section 511.75 The SBA Office of Advocacy expressed these concerns in a letter to Senator Craig in 2006, explaining that section 511 would "in

hibit[] the efficient use of capital because it will limit funds that can be used to reinvest in the business" and would present serious cash management issues,

increasing the already heavy burden on small business owners.76

Additionally, several small business organizations have joined the GWRC in an attempt to force the repeal.77 The GWRC made a statement for the record before the House Committee on Small Business on March 22, 2007,

citing the many additional costs that section 511 will impose on small busi nesses.78 Calling section 511a new hidden tax on small businesses, the GWRC

expressed concern over increased administrative costs to businesses, the bur den it places on the cash flow of small businesses, and how the provision un

fairly burdens compliant taxpayers.79 Individual members of the GWRC also addressed their concerns before the House Committee on Small Business. Statements by members of the Coalition include the following:

"Withholding is particularly problematic because it reduces capital needed for day-to-day operations_To cover their costs, government contractors will need to increase their bid rates for government projects in order to maintain the same profit margins."80 "A small business that receives 90% of their revenue from government business will find it difficult to stay afloat and will eventually be driven out of the federal marketplace and out of business."81 "This provision under IRC 3402(t), if implemented, will have a negative impact on cash flow.... The result would, in turn, mean less competition for governmental jobs, and therefore more cost to taxpayers."82

75. See Letter from Thomas M. Sullivan, Chief Counsel for Advocacy, Small Bus. Admin., to Sen. Larry Craig (Aug. 31, 2006), available at http://www.sba.gov/advo/laws/comments/craig06_ 0831.html.

76. Id. 11. See Government Withholding Relief Coalition, http://www.withholdingrelief.org/portal/

gwrc/default (last visited Nov. 10, 2008). 78. Government Withholding Relief Coalition, Statement for the Record to the H. Comm.

on Small Business on the New Hidden Tax on Small Business (Mar. 22, 2007), available at http:// www.withholdingrelief.org/portal/gwrc/default (follow Coalition Letters "March 22, 2007"

hyperlink). 79. Id. 80. U.S. Chamber of Commerce, Statement for the Record to the H. Comm. on Small

Business on the New Hidden Tax on Small Business (Mar. 22, 2007), available at http://www. withholdingrelief.org/portal/gwrc/letters.htm (follow "U.S. Chamber of Commerce" hyperlink).

81. The Coalition for Government Procurement, Statement for the Record to the H. Comm. on Small Business on the New Hidden Tax on Small Business (Mar. 22, 2007), available at http:// www.withholdingrelief.org/portal/gwrc/letters.htm (follow "The Coalition for Government Procurement" hyperlink).

82. Associated Builders and Contractors, Statement for the Record to the H. Comm. on Small Business on the New Hidden Tax on Small Business (Mar. 22, 2007), available at http://www. withholdingrelief.org/portal/gwrc/letters.htm (follow "Associated Builders and Contractors"

hyperlink).




In response to the fears expressed by contractors over the application of section 511 such as those listed above, members of the 110th Congress intro duced H.R. 1023 and S. 777 in an effort to repeal the provision.83 Although these bills appeared to have bipartisan support, they did not advance in the

legislative process.84 Another bill proposed in reaction to section 511 sought to

delay the implementation of the withholding for another year until December 2011.85 This bill also died because Congress failed to sign it into law before the end of their session.86 Included in the bill was a recommendation that the

Secretary of the Treasury complete further studies to better understand the effects of section 511 's application before it is actually implemented.87

The opposition to the withholding is not surprising given the history of in come tax withholding.88 The current system of withholding of federal income taxes began in 1943 in the face of opposition.89 In the 1970s and 1980s, efforts

were made to expand withholding to payments to independent contractors as well as on dividends and interest.90 Section 301 of the Tax Equity and Fiscal

Responsibility Act of 1982 (TEFRA) authorized a 10% withholding on in terest and dividends.91 However, the provision was repealed in response to

public opposition one month after the withholding was to begin.92 With the

repeal of the withholding provision, Congress expanded information report

ing for interest and dividends coupled with backup withholding for specific noncompliant taxpayers.93 The withholding of taxes from payments to gov ernment contractors is receiving a similar response to that of the withholding on dividends and interest, and will likely lead to the same result: a repeal of the provision.

VI. COST-BENEFIT ANALYSIS OF SECTION 511

A. Benefits There is a potential of great benefit to the Government in allowing sec

tion 511 to be implemented in 2010 as originally planned. One of the most

83. H.R. 1023, 110th Cong. (2007); S. 777, 110th Cong. (2007). 84. This delay is most likely because section 511 does not take effect until 2011, presenting no

rush for passing the legislation. 85. H.R. 3056,110th Cong. (2007). 86. Id.; Library of Congress, Bill Summary and Status, H.R. 3056, http://thomas.loc.gov/

cgi-bin/bdquery/z?dll0:h.r.03056: (last visited Nov. 10, 2008). 87. H.R. 3056, 110th Cong. ? 3 (2007). 88. See generally Charlotte Twight, Evolution of Federal Income Tax Withholding: The Machinery

of Institutional Change, 14 Cato J. 359 (1995) (discussing the history of withholding taxes and the reactions thereto).

89. Mat 369-81. 90. Id. at 385. 91. Tax Equity and Fiscal Responsibility Act of 1982, Pub. L. No. 97-248, ? 301,96 Stat. 324,

576-85. 92. Twight, supra note 88, at 390. 93. Interest and Dividend Tax Compliance Act of 1983, Pub. L. No. 98-67, ?? 102, 104, 97

Stat. 369, 369-80.




persuasive arguments made by supporters of section 511 is that it will cover

the tax gap of government contractors by raising nearly $7 billion in revenue

between 2011 and 2015.94 This is true because by withholding taxes from

payments to contractors, the IRS is ensuring payment of taxes owed up to the 3% rate.95 Because there is forced compliance through withholding, contrac tors are discouraged from failing to file and from underreporting.96 This not

only will benefit the Government, but also will benefit those contractors who do file accurately but receive heavy tax bills at the time of filing.97 By with

holding a portion of taxes due at the time of payment, the tax burden is spread out over the entire year instead of the one-time bill.98 Spreading out the tax

obligations over the year also allows the IRS to decrease the number of con tractors who cannot pay their tax bill in full when they file, thus easing the ad

ministrative burden on the IRS and decreasing the number of payment plans that need to be negotiated. Further, although the withholding of taxes does not correct past delinquencies, it prevents future delinquencies. In conclu

sion, this solution is more progressive than previous attempts because it serves to prevent future abuse as opposed to merely mending past abuse.

Another benefit of section 511 is that it diminishes the advantage of those contractors who do not comply with the tax laws.99 Contractors who have been able to contract with the Government despite their failure to pay taxes are able to bid lower on contracts because their failure to comply with tax laws minimizes costs.100 The lack of penalties to these noncompliant contractors

impedes the fairness of the government procurement system. This is particu larly true for larger contractors because the larger the contract, the greater the tax savings from their failure to comply101

This benefit is extremely important because integrity and transparency are main goals for a successful government procurement system.102 Lack of faith in the Government's procurement system caused by an impression of unfairness leads to fewer participants in the system and thus decreases competition.103

Decreased competition leads to less-favorable contracts for the Government

94. Joint Comm. on Taxation, Estimated Revenue Effects of the Conference Agreement for "The Tax Increase Prevention and Reconciliation Act of 2005" (May 9, 2006), available at http://www.house.gov/jct/x-18-06.pdf.

95. See Dep't of the Treasury, Internal Revenue Serv., Nat'l Taxpayer Advocate, 2003 Annual Report to Congress 256, available at http://www.irs.gov/pub/irs-utl/nta_2003_annual_ update_mcw_l-15-042.pdf [hereinafter 2003 Annual Report to Congress].

96. Id. 97. Id. 98. See id. 99. See id. 100. See id. 101. This is true not only because the greater the income received, the greater the taxes that

are owed; but also because these contractors are presumably in higher tax brackets and are saving a greater percentage of income. See I.R.C. ? 1 (2000), for tax rates for individuals and small busi nesses, and I.R.C. ? 11 (2000), for tax rates for corporations.

102. See Schooner, supra note 4, at 103. 103. Id. at 104-05.




in terms of both price and quality of goods and services offered.104 However, as discussed later, section 511 may actually decrease both competition and fairness in another respect.105

Another factor that is often considered when dealing with tax collection is the time value of money. By withholding the taxes from contractors at the time of payment, the Government is gaining the use of these funds to invest and use as it sees fit. The contractors are effectively making interest-free loans to the Government through advanced payment of their taxes. This is a clear

advantage for the Government, as a dollar today is always better than a dollar tomorrow. Not only is the Government benefiting from extra compliance, it is also receiving the tax receipts earlier than if the contractors had properly filed. Although this is a benefit to the Government and a cost to contractors, it is a fair application of the law due to contractors' tendency toward being de

linquent in paying their taxes. Forced interest-free loans from nondelinquent contractors is less fair because contractors will be forced to bear the cost of

paying taxes earlier as well as the other costs of the withholding discussed below due to no failure of their own.

B. Costs

Section 511 also can impede both fairness and competition in the bidding process. The withholding of taxes upon payment could obstruct small busi nesses from bidding on contracts because of the burden it places on their cash flow.106 Preventing many small businesses from participating in government procurement clearly limits competition and would make the system more un

just, favoring big business over small. Further, as Senator Craig noted when TIPRA was passed, "[a]s portions of income are withheld for as long as fifteen

months, cash flows will drop and opportunities to invest will go down. These

expenses will result in a higher cost of business."107 The higher costs on these businesses could make contracting with the Government prohibitive, thereby reducing the number of small businesses benefiting from contracts with the

Government. Further, the withholding will create a competitive advantage for those contractors who have both private and government contracts over those contractors whose revenue comes mainly from government contracts, as it will have less of an impact on the contractor's cash flow.108

The limits on contractor cash flow that the withholding causes also conflict with collateral socioeconomic policies that provide greater opportunities to

small businesses through government contracting. By forcing small businesses out of competition for contracts, Congress is increasing the disadvantage that small businesses already face when competing against larger corporations

104. Id. at 104. 105. See infra Part VLB. 106. See 152 Cong. Rec. S4385, S4422 (daily ed. May 11, 2006) (statement of Sen. Craig). 107. Id. 108. Id.




who have greater resources and thus can make lower bids. Congress needs to consider which of these policies it finds more valuable since the policies come in such great conflict.

Moreover, the withholding tax applied is a flat 3% tax rate. This flat tax,

although easy to calculate, can create disparities in cash flows because it can lead to either overholding or underholding depending on the size of the con tractor and the nature of the contract.109 Contractors who are providing goods as opposed to services generally have a lower profit margin, and are thus more

likely to bear a greater burden of the flat tax and be subject to an overholding of taxes.110 Those who provide services have a larger profit margin and will most likely bear a lower burden and be subject to an underholding of appro priate taxes.111 Consequently, although the application of the flat tax is simple, the effects of the underholding and overholding can lead to further compli cations to the IRS and further filings by the contractors. However, a brack eted withholding tax would cause additional administrative costs because of its complexity. The relatively conservative flat rate of 3 % will limit instances of overholding112 but will also decrease the efficacy of ensuring compliance because of the significant chance of underholding on payments made to larger contractors.

Another issue that section 511 presents is the direct cost imposed on con tractors that are still able to bid on government contracts. Even those who are not forced out of the government procurement system because of the higher costs of contracting will most likely increase their bids to compensate for with

holding. The resulting higher bids also are contrary to the Government's goal of obtaining the best value.113 This should be of serious concern to Congress because the higher procurement costs to agencies will offset some of the gain received from the increased revenue from the withholding.

It also has been argued that there will be increased administrative costs to agencies due to the withholding requirement.114 At the completion of the

GAO study of defense contractors in 2004, the DoD had yet to modern ize its financial accounting systems to properly manage the TOP levy pro gram discussed above, which was implemented eight years earlier in 1996.115 The DoD's systems were decentralized into twenty-two different payment systems, making it difficult to even report the payments made to contrac tors.116 In 2003, the DoD requested $18 billion for operation, maintenance, and modernization of their business systems.117 Expanding the DoD's systems

109. Joint Comm. on Taxation, supra note 57, at 8. 110. Id. 111. Id. 112. Id. 113. See Schooner, supra note 4, at 103. 114. See Joint Comm. on Taxation, supra note 57, at 9. 115. See Some DOD Contractors Abuse the Federal Tax System with Little Conse

quence, supra note 9, at 20. 116. Id. 117. Id.




to provide for the withholding would be even more complicated and would create even greater costs.118

Similar concerns were addressed when Congress was considering the im

plementation of H.R. 4181, which would bar delinquent contractors from

receiving contracts.119 In response to this bill, the GAO stated that "efforts to address delinquent federal debt must be cost effective."120

There are direct tangible costs that Congress should estimate and offset with the benefits of increased revenue before the implementation of section 511 is even considered. Overall, the benefits of section 511 seem to be far

outweighed by both direct and indirect costs.

VII. DETAILED ANALYSIS OF SECTION 511

A. Why Should Agencies Pay for the Failure of the IRS to Collect Taxes?

A broader question often addressed when dealing with collateral socio economic policies is why government agencies must deal with the costs of their implementation. These policies generally place their goals in front of the directives of the procuring agencies. Although these collateral policies

may have goals that are superior to those of the procuring agencies, the cu

mulative effect of these policies must be considered and rational judgment should be made as to which deserve to be implemented. Specifically in this

case, the IRS is diverting its responsibility in collecting taxes and placing it on

other agencies. This problem seems to be recurring as this is not the first time that the IRS has attempted to use government contracting to decrease the tax

gap.121 Currently, agencies are still required to report payment information as

required by the TOP program, and payments of contractors are still subject to the levy program of the Taxpayer Relief Act of 1997. Combined, these pro grams place significant administrative burdens on agencies. The IRS should

manage its responsibilities and should only delegate duties when necessary and at minimum cost.

B. Why Will This Program Be More Efficient Than Previous

Attempts by the IRS to Use the Government Procurement System to Collect Taxes?

An important question that both the IRS and Congress should ask is why this law will be more effective than past attempts of the IRS to collect taxes

with the assistance of other government agencies. Past performance of the

118. See 152 Cong. Rec. S4385, S4422 (daily ed. May 11, 2006) (statement of Sen. Craig). 119. Barring Delinquent Taxpayers from Receiving Federal Contracts and Loan

Assistance, supra note 26, at 8. 120. Id. 121. See Taxpayer Relief Act of 1997, 26 U.S.C. ? 63 31 (2000); Debt Collection Improvement

Act of 1996, Pub. L.No. 1041-34, HOStat. 1321,1321-358 to 381 (codified in scattered sections

of 26 U.S.C, 28 U.S.C, 31 U.S.C, and 42 U.S.C).




TOP and the FPLP has shown that these attempts have failed to collect sufficient taxes because of both the lack of technological ability to report contractor payments and the IRS's own policies that limited the number and type of contractors covered by these programs.122 However, the delay in implementation of section 511 may allow for the IRS and other affected

agencies to modernize their systems to alleviate some of the problems from

prior attempts. The modernization of the financial systems before this policy is implemented would solve some of the problems present in the TOP and

FPLP, but still would be costly both administratively and in terms of compe tition for contracts.

C. Why Is the Withholding Applied Against Government Contractors and Not Payments Made to All Independent Contractors?

Analogous to the question of why these policies are forced upon agencies during procurement is why the law is not imposed on independent contrac tors in the private sector. The IRS also recommended withholding for inde

pendent contractor payments in the private sector,123 but Congress chose to

implement this withholding requirement only against government contrac tors.124 When the JCT made its recommendations, it advised against imposing the broader requirements against the private sector because of the "additional administrative burdens on the private sector and on both payors and pay ees."125 The question that arises is why Congress was more worried about the administrative burdens imposed on private companies than those imposed on the Government. It could be that Congress was worried about backlash from the private sector in excess of what it has encountered from the legislation as enacted. In essence, the IRS and Congress are taking advantage of the spe cial relationship they have with government agencies. Although government agencies serve the public as part of the Government, it is difficult for them to

manage their respective missions when also forced to deal with the duties and

obligations of the IRS. One justification for placing the burden of withholding on government agencies and not those in the private sector is that the taxes withheld will help the Government at large, and indirectly those agencies. While the private sector's benefit from increased tax compliance is even less

direct, benefiting only from a better-funded Government, this could help the

economy or provide for other benefits for private companies in the future.

D. Implementation Against State and Local Entities

The justification of increased revenue to the Federal Government does not pertain to state and local agencies. Section 511 places limits on the size

122. See Federal Payment Levy Program Measures, Performance, and Equity Can Be

Improved, supra note 21, at 9-14. 123. See 2003 Annual Report to Congress, supra note 95, at 263. 124. Joint Comm. on Taxation, supra note 57, at 9. 125. Id.



Tax Increase Prevention & Reconciliation An of2005 Section 511 467

of the state and local government entity that is required to withhold the taxes and places the withholding obligations only on government entities that make

$100 million in qualifying payments annually.126 Although the burden is not

placed on smaller state governments and agencies, the burden is still placed on entities who are not receiving the benefit of greater revenues because they are not part of the Federal Government. In this sense, the impact on state and local entities is similar to what it would have been on the private sector, yet Congress felt justified in placing this administrative burden on them.

E. Cumulative Effects of Collateral Socioeconomic Policies

The aggregate effects of the many collateral socioeconomic policies on

the government procurement system are significant. One wonders whether

funding for small businesses and other concerns could be found through the

savings the Government might have if it had allowed the government pro curement system to stand on its own. Nonetheless, it is impracticable to be lieve that these collateral policies will ever disappear completely because the

underlying motives behind many of them are important to the congressmen who support them. Congress should limit the number of collateral policies, wherever possible, to those that it finds to be most important in order to limit unwanted costs. Although it can be argued that these collateral policies are

justified by the special role that the Government plays in society, the poli cies tend to counteract the ability of the Government to spend the taxpayer's

money wisely and efficiently. In the end, a balancing of interests would re

sult in limits to the use of these policies as this Note advises. Section 511 of TIPRA should be one of these policies that is subverted to the needs of an

effective government procurement system.

F. Solution Through Amending Section 511 ?

Although it is clear that the costs of implementing section 511 far outweigh the benefits, there are some ways that the costs could be lessened. Specifically, to minimize the negative impact that the withholding places on small busi

nesses, Congress could create an exemption for small businesses so that they would not be subject to withholding. This would allow small businesses to bid

and compete with larger contractors because they would not be forced out of

the process due to constraints on cash flow. However, there is a chance that

this exemption to the withholding requirement could lead to further excep tions and result in the same problem the IRS faced with the implementation of TOP and FPLP. Placing restrictions on the program will reduce its efficacy and could lead to further argument that section 511 should be repealed.

A possible solution to the increased costs imposed on agencies due to the

implementation of section 511 is for the agencies to receive extra funding to

126. Tax Increase Prevention and Reconciliation Act of 2005, Pub. L. No. 109-222, ?511,120 Stat. 345, 364-65 (2006) (to be codified at 26 U.S.C. ? 3402(t)).




manage this new obligation. Although the withholding provision will bring in actual revenues as opposed to other collateral socioeconomic policies, the revenues that are recouped do not benefit the procuring agency directly. The

money recouped through the withholding will be directed to the U.S. Treasury and not to individual agencies. The agencies will only see these funds if they are directly appropriated to them in their individual procurement budgets. A portion of the revenues collected could be allocated toward each agency that effectively follows the requirements of section 511, to better offset their costs. This would counteract some of the costs imposed. Specifically, Congress could appropriate more money to these agencies to cover any ad ministrative costs that must be incurred to modernize their financial systems so that they can effectively implement the withholding. However, this would

only address the direct costs to procuring agencies and would not address costs to contractors and burdens on competition.

Another option would be for Congress to repeal section 511 and amend the FAR, as suggested in the Good Government Contractor Act of 2007 and the proposal for amendment by the Civilian Agency Acquisition Council and the Defense Acquisition Regulations Council, to require COs to con sider tax delinquency in a determination of responsibility as well as to con sider delinquency a cause for suspension.127 A similar amendment to the FAR was considered in the past and failed to survive, but this provision seems to be more consistent with the goals of fairness and competition than

TIPRA.128 This program may not specifically collect more revenue for the IRS than section 511 of TIPRA, but it will prevent future delinquencies from prospective contractors and will create an incentive for them to pay past debts. Although this alternative could present some issues for small businesses regarding their ability to contest responsibility findings, it would afford them better treatment than section 511, which could push them out of the competition for government contracts altogether.

VIII. CONCLUSION

Section 511 of TIPRA is another example of a collateral socioeconomic

policy forced upon the government procurement system that has unwanted effects. The costs of TIPRA far outweigh the potential benefits, and for this

reason, the law should be repealed before it takes effect. The government pro curement system should stand on its own and act to minimize costs without the influence of socioeconomic policies wherever possible. The Government should not use the leverage it has over government contractors to force com

pliance with tax laws in this manner because it hinders the true policies of the federal procurement system.

127. See S. 2394, 110th Cong. ?? 2, 3, 8 (2007). 128. See FAR Case 1999-0010, Contractor Responsibility, Labor Relations Costs, and Costs

Related to Other Legal Proceedings, 65 Fed. Reg. 80,256, 80,256-63 (Dec. 20, 2000).



Documents

WITHHOLDING TAXES: TOO TAXING ON GOVERNMENT PROCUREMENT