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March 15, 2009


Congress, Corporations, and Accounting Gimmicks
By George Scoville

In 2006, a new 3% withholding measure – known as Section 511 – was added without debate to the Tax Increase Prevention and Reconciliation Act (TIPRA) when the bill came before the Conference Committee. The new rule requires that federal, state, and local governments withhold three percent from all payments for goods and services, including Medicare payments, farm aid, and grants to for-profit entities.

Section 511 aims to collect unreported tax revenues from contractors who default on income tax payments, and will take effect in 2011. In the final days of the 109th Congress, some Members endeavored to accelerate the implementation date of this provision to raise revenue for new discretionary appropriations. Under current “pay-go” rules, which attempt to hinder deficit spending in discretionary programs, Members of Congress will continue to try to accelerate the implementation date.

Section 511 will have a significant impact on the nation’s economy, especially the contracting community. The administrative costs to the government, as well as to companies, are substantial. Companies’ internal systems are not set up to track these payments, nor are government systems set up to receive such payments.

In reality, Section 511 is an interest-free loan from the contractor community to the government. The $7 billion in “increased revenue” derived from this legislation from 2011 to 2015 represents the contractors’ tax payments to the government in advance, via the 3% withholding. However, this provision only generates $215 million of improved tax compliance in 2012 and increases slightly in each of the following years. Companies will be able to recover the difference of the 3% withholding and their respective tax liability when they file their returns each spring. This means that over $6.5 billion of the estimated $7 billion of revenue comes from an accounting gimmick.

A recent Department of Defense study indicated that, for its portfolio of contracts alone, the cost of implementing the 3% withholding program would require approximately $17 billion in government expenditures. If the aim of the withholding is to raise $7 billion in revenue, DoD’s contract spread alone makes the program a $10 billion loser.

The withholding will be especially burdensome on small businesses that function on a very small profit margin (most function on a 2-2.6% margin). Many small businesses will be forced to either incur higher levels of debt to ensure the regular cash flows necessary for day-to-day operations, or abandon their work with the government altogether. When most businesses foresee an increase in operating cost, that cost is usually passed off to the consumer in the form of a price increase. The financial burden of this provision will flow down to subcontractors and ultimately cost the taxpayer more because of increased prices.

Section 511 is an unfunded mandate on state and local governments. Federal tax compliance enforcement is the function of the IRS, not of the state and local governments, or of Congress for that matter. This program is an unfair burden on lower levels of government. Congress must repeal Section 511 of the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222) to avoid a staggering price increase that will burden consumers in a faltering national economy and global recession and will create a bureaucratic nightmare at the state and local levels.

George Scoville is a senior Philosophy and Political Science double major.

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