.
Tax Gap: Should the 3% Withholding
Requirement on Payments to Contractors by
Government Be Repealed?
James M. Bickley
Specialist in Public Finance
September 12, 2011
Congressional Research Service
7-5700
www.crs.gov
R41924
CRS Report for Congress
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epared for Members and Committees of Congress
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Should the Withholding Requirement on Payments to Contractors Be Repealed?
Summary
The Internal Revenue Service (IRS) defines the gross tax gap as the difference between the
aggregate tax liability imposed by law for a given tax year and the amount of tax that taxpayers
pay voluntarily and timely for that year. It defines the net tax gap as the amount of the gross tax
gap that remains unpaid after all enforced and other late payments are made for the tax year.
On January 27, 2005, the Joint Committee on Taxation (JCT) published a report titled Options to
Improve Tax Compliance and Reform Tax Expenditures. The JCT report identified many options,
including several to increase withholding. The first option was titled “Impose Withholding on
Certain Payments Made by Government Entities.” The JCT argued that the IRS had extensively
and successfully used withholding and information reporting to improve tax compliance.
Furthermore, much empirical data supported the use of withholding and information reporting to
reduce the tax gap. On May 16, 2006, President George W. Bush signed the Tax Increase
Prevention and Reconciliation Act of 2005 (P.L. 109-222), which included Section 511:
“Imposition of Withholding on Certain Payments Made by Government Entities” (the JCT
option). This section required 3% withholding on payments for goods and services to contractors
made by all branches of the federal government and its agencies and all units of state and local
governments, including counties and parishes. Local governments with less than $100 million of
annual expenditures were excluded from the withholding requirement. The section also imposed
information reporting requirements on payments that are subject to withholding. This section was
a revenue offset and was scheduled to take effect on January 1, 2011.
Substantial opposition developed to this withholding provision. Critics argued that the public and
private compliance costs were unacceptable, existing IRS enforcement tools were adequate, and
privacy would be reduced. The American Recovery and Reinvestment Act of 2009 (P.L. 111-5)
delayed the implementation of the withholding provision until January 1, 2012. On May 5, 2011,
the IRS issued regulations that further delayed the implementation of the withholding provision
until January 1, 2013.
In the 112th Congress, three bills to repeal the Section 511 withholding provision have been
introduced: S. 89, S. 164, and H.R. 674. In addition, S.Amdt. 405 to S. 782, Economic
Development Revitalization Act of 2011, would repeal the withholding provision.
The IRS has attempted to address concerns about compliance costs by proposing a $10,000
threshold on government purchases from contractors and increasing the number of exemptions.
Furthermore, there is the possible issue of finding a replacement revenue source. Currently,
verifiable data do not exist to objectively compare the costs with the benefits of implementing the
3% withholding requirements.
On August 23, 2011, House Majority Leader Eric Cantor issued a press release, which stated that
in September 2011, the House “will repeal the ‘3 percent withholding rule,’ which serves as an
unnecessary tax increase on those who do business with the government.”
This report will be updated as issues develop, legislation is introduced, or as otherwise warranted.
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Should the Withholding Requirement on Payments to Contractors Be Repealed?
Contents
Introduction...................................................................................................................................... 1
Arguments for the Withholding Requirement.................................................................................. 2
Widespread IRS Withholding and Information Reporting Reduce the Tax Gap....................... 2
Empirical Support...................................................................................................................... 2
IRS Data .............................................................................................................................. 2
GAO Studies ....................................................................................................................... 3
Arguments for Repeal of Withholding Requirement ....................................................................... 3
Compliance Costs...................................................................................................................... 3
Existing IRS Tools..................................................................................................................... 4
Privacy....................................................................................................................................... 4
Legislative Action Since Enactment of the Withholding Provision................................................. 5
Repeal Legislation in the 110th and 111th Congresses ................................................................ 5
Implementation Delay Included in ARRA ................................................................................ 5
Proposed Repeal Legislation in 112th Congress ........................................................................ 5
Implementation Delay by IRS ......................................................................................................... 6
Conclusions...................................................................................................................................... 7
Figures
Figure A-1. Tax Year 2001............................................................................................................... 8
Figure A-2. Individual Income Tax Underreporting Gap, 2001....................................................... 9
Tables
Table A-1. Individual Income Tax Underreporting Gap, 2001 ........................................................ 9
Appendixes
Appendix A. Tax Gap Data for 2001 ............................................................................................... 8
Appendix B. JCT 2005 Option of Withholding on Payments to Government............................... 11
Appendix C. GAO Studies of Tax Evasion by Federal Contractors .............................................. 13
Contacts
Author Contact Information........................................................................................................... 14
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Should the Withholding Requirement on Payments to Contractors Be Repealed?
Introduction
The Internal Revenue Service (IRS) defines the gross tax gap as the difference between the
aggregate tax liability imposed by law for a given tax year and the amount of tax that taxpayers
pay voluntarily and timely for that year.1 It defines the net tax gap as the amount of the gross tax
gap that remains unpaid after all enforced and other late payments are made for the tax year.2 For
tax (calendar) year 2001 (the most recent year available), the IRS estimated a gross tax gap of
$345 billion, equal to a noncompliance rate of 16.3%.3 For the same tax year, IRS enforcement
activities, coupled with other late payments, recovered about $55 billion of the gross tax gap,
resulting in an estimated net tax gap of $290 billion.4 The estimated gross tax gap of $345 billion
consisted of underreporting of tax liability ($285 billion), nonfiling of tax returns ($27 billion),
and underpayment of taxes ($33 billion).5 For 2001, the $285 billion of underreporting of tax
liability had the following components: $197 billion in individual income tax, $54 billion in
employment tax, $30 billion in corporate income tax, and $4 billion in estate taxes.6
On January 27, 2005, the Joint Committee on Taxation (JCT) published a report titled Options to
Improve Tax Compliance and Reform Tax Expenditures.7 The JCT report identified many
options, including several to increase withholding. The first option was titled “Impose
Withholding on Certain Payments Made by Government Entities.” This option would require 3%
withholding on payments for goods and services to contractors made by all branches of the
federal governments and its agencies and all units of state and local governments, including
counties and parishes. Local governments with less than $100 million of annual expenditures
would be excluded from the withholding requirement. The withholding proposal would also
impose information reporting requirements on payments that are subject to withholding. The JCT
argued that the IRS had extensively and successfully used withholding and information reporting
to improve tax compliance. Furthermore, much empirical data supported the use of withholding
and information reporting to reduce the tax gap.8
On May 16, 2006, President George W. Bush signed the Tax Increase Prevention and
Reconciliation Act of 2005 (TIPRA; P.L. 109-222), which included Section 511: “Imposition of
Withholding on Certain Payments Made by Government Entities” (the JCT option). Furthermore,
the explanation of Section 511 by the Joint Committee on Taxation (“JTC Section 511
Explanation”),9 was essentially a summary of the JCT revenue proposal published in the JCT
report about options. This section was a revenue offset and was scheduled to take effect on
1 Internal Revenue Service, Reducing the Federal Tax Gap: A Report on Improving Voluntary Compliance, August 2,
2007, p. 6. Pages 9-16 of this reference are the source of the data about the tax gap shown in Appendix A.
2 Ibid., pp. 9-10.
3 The noncompliance rate is the percentage of the aggregate tax liability that taxpayers do not pay voluntarily and in a
timely manner for a given year.
4 Internal Revenue Service, Reducing the Federal Tax Gap: A Report on Improving Voluntary Compliance, p. 10.
5 Ibid.
6 Ibid.
7 Joint Tax Committee, Options to Improve Tax Compliance and Reform Tax Expenditures, Report no JCS-02-05,
January 27, 2005, 430 p.
8 For a more detailed description of the JCT 2005 option, see Appendix B.
9 Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 109th Congress, committee print
no. JCS-1-07, January 7, 2007, pp. 309-311.
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January 1, 2011. This new withholding provision would raise revenue by improving tax
compliance and thus reducing the tax gap. The JCT estimated that the provision would yield
$6.977 billion over FY2011-FY2015.10
Currently, this 3% withholding provision is a subject of congressional debate. This report
discusses arguments for and against the withholding provision, proposed repeal legislation in the
110th and 111th Congresses, two delays in implementation, and proposed repeal legislation in the
112th Congress.
Arguments for the Withholding Requirement
Both the JCT Options Report and the JCT Section 511 Explanation maintain that mandatory
withholding and information reporting substantially improve tax compliance and reduce the tax
gap. These JCT publications present arguments for this position. Models of tax compliance
assume that the tax gap will be reduced when potential tax evaders perceive that their probability
of being caught is increasing. Many individuals compare the expected benefits of tax evasion
against the expected costs in theory.11
Widespread IRS Withholding and Information Reporting Reduce
the Tax Gap
Both JCT publications emphasize the extensive use of withholding and information reporting by
the IRS under current law in order to reduce the tax gap. Employers are required to withhold
employment and income taxes from wages and salaries. Certain non-wage payments are subject
to mandatory or voluntary withholding. For examples, payors of pensions are required to
withhold from payments made to payees, unless the payee elects no withholding, and a variety of
payments (such as interest and dividends) are subject to backup withholding if the payee has not
provided a valid taxpayer identification number.12 Thus, withholding and information reporting
are widely and successfully used by the IRS to reduce the tax gap. A detailed presentation is
included in Appendix A.
Empirical Support
IRS Data
IRS empirical research has consistently shown that withholding and information reporting
substantially improve tax compliance and thus reduce the tax gap. The most recent IRS
calculation of the tax gap was for tax year 2001, which was based on randomly selected 46,000
10 Joint Committee on Taxation, Estimated Revenue Effects of the Conference Agreement for the “Tax Increase
Prevention and Reconciliation Act of 2005,” Report number JCX-18-06, May 9, 2006, p. 2.
11 For a comprehensive review of the literature on tax compliance, see James Adreoni, Brian Erard, and Jonathan
Feinstein, “Tax Compliance,” Journal of Economic Literature, vol. 36, no. 2, June 1998, pp. 818-860. For an overview
of the economics of tax evasion, see Joel Slemrod, “Cheating Ourselves: The Economics of Tax Evasion,” Journal of
Economic Perspectives, vol. 21, no. 1, winter 2007, pp. 25-48.
12 Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 109th Congress, pp. 309-310.
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returns.13 High-income returns were deliberately oversampled in order to draw conclusions about
this important sub-category of taxpayers concerning the use of withholding to decrease the tax
gap.14 The results indicate that the individual income tax underreporting gap increased as
information reporting declined and the withholding requirement ended. A detailed presentation is
included in Appendix A.
GAO Studies
The Government Accountability Office has found widespread tax evasion by federal contractors.
These GAO studies used IRS records, agency data, and results from their own investigations.15 It
can be argued that tax evasion by federal contractors would be reduced by the contractor
withholding provision.
Arguments for Repeal of Withholding Requirement
After the passage of the 3% contractor withholding provision in TIPRA, significant opposition
arose against its implementation. On March 22, 2007, the House Small Business Committee held
a hearing on the “Potential Effects on Small Businesses of 3 Percent Withholding Provisions on
Government Contracts.” On May 26, 2011, the Subcommittee on Contracting and Workforce of
the House Small Business Committee held a hearing titled “Defer No More: The Need to Repeal
the 3% Withholding Provision.”
At these hearings and in other public statements by trade associations and public entities, several
arguments have been expressed against the 3% contractor withholding provision.
Compliance Costs
Opponents argue that the 3% contractor withholding provision would impose unacceptable costs
on businesses and government entities. Overwithholding will occur if a business has a low profit
margin or no income tax liability. Thus, some businesses would provide the federal government
with an interest-free loan. Some critics argue that the 3% withholding requirement will adversely
affect some businesses and government entities more than others. These critics maintain that
small businesses and small government entities will have to pay relatively more to comply with
the withholding requirement. But the relative compliance costs of business and government
entities of different sizes is unknown.
On May 26, 2011, at a House Small Business Committee hearing, the representative for the
American Institute of Certified Public Accountants (AICPA) testified that
Our CPA members who provide services to state and local governments are hearing that
these governmental entities consider the 3 percent withholding law to be an unfunded
mandate, causing significant challenges for governmental accounting and procurement
systems. Similarly, state and local governments are also informing our members that this
13 Internal Revenue Service, “Understanding the Tax Gap,” FS-2005-14, March 2005, p. 1.
14 Ibid.
15 The results of three of these GAO studies are shown in Appendix C.
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need to reprogram systems (to comply with the law) will likely prove a costly task,
particularly during a period of budgetary imbalances and difficult economic times.16
A statement for the record of the hearing from the U.S. Chamber maintained that
In order to comply with the mandate, companies of all sizes that do business with the
government will need to develop new internal accounting systems to track, handle and
reconcile these payments. The cost to develop these systems will be passed on to the
government, with the ultimate cost being borne by individual taxpayers. The 3% withholding
tax is particularly problematic because it reduces capital needed for day-to-day operations.17
The statements and testimony before the House Small Business Committee lack verifiable data.
No data-based estimate is available concerning the compliance costs that the proposed 3%
withholding provision would impose on federal, state, and local governmental entities and
businesses.
Existing IRS Tools
Some repeal proponents argue that the existing tools of the IRS are sufficient to enforce tax laws
for government contractors. Thus, the IRS does not need the additional tool of the proposed 3%
withholding. For example, the representative for AICPA testified that the
IRS already has a number of tools in place to address taxpayers with federal tax liabilities
without the need for governments to resort to 3 percent withholding on payments. Some of
these tools included (among others): (1) the Federal Awardee Performance and Integrity
Information System, involving a federal (legal and tax compliance) data base that the
government employees and grant officials are required to review before awarding a federal
prime contract; and (2) tax compliance certifications, requiring government contractors to
certify that the offeror and its principals have no delinquent federal taxes with a delinquency
grounds for suspension and disbarment.18
In addition, the IRS, in conjunction with the Financial Management Service (FMS) of the
Department of Treasury, operate the Federal Payment Levy Program, which collects overdue
taxes through a continuous levy on certain federal payments disbursed by FMS.19
Privacy
Some critics are concerned about the possible reduction in privacy if the IRS collects and cross-
checks more data. They argue that as the authority of the tax collector increases, the possibility of
the misuse of tax information rises.20 But many federal laws and regulations are in place to
16 Patricia A. Thompson, Statement on Behalf of the American Institute of Certified Public Accountants, House
Committee on Small Business, Hearing on “Defer No More: The Need to Repeal the 3 Percent Withholding Provision,”
May 26, 2011, pp. 2-3.
17 U.S. Chamber of Commerce, Statement for the Record, submitted to House Committee on Small Business, Hearing
on “Defer No More: The Need to Repeal the 3% Withholding Provision,” May 26, 2011, p. 3.
18 Patricia A. Thompson, p. 2.
19 Internal Revenue Service, Federal Payment Levy Program, p. 1. Available at http://www.IRS.gov.
20 Linda J.B. McKee and Thomas E. McKee, “Proposed Tax Gap Legislation Erodes Individual Privacy and
Protections,” The CPA Journal, April 1, 2010, pp. 6, 8-9.
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safeguard taxpayer data.21 Criminal and monetary penalties may be levied on parties for
unauthorized disclosures or uses of taxpayer data.22
Legislative Action Since Enactment of the
Withholding Provision
Repeal Legislation in the 110th and 111th Congresses
In the 110th and 111th Congresses, several bills to repeal the contractor withholding requirement
were introduced. Three bills to repeal were introduced in the 110th Congress: H.R. 1023, To
Repeal the Imposition of Withholding on Certain Payments Made to Vendors by Government
Entities; S. 777, Withholding Tax Relief Act of 2007; and S. 2394, Good Government Contractor
Act of 2007. Further, two repeal bills were introduced in the 111th Congress: H.R. 275, To Repeal
the Imposition of 3 Percent Withholding on Certain Payments Made to Vendors by Government
Entities; and S. 292, Withholding Tax Relief Act of 2009.
Implementation Delay Included in ARRA
On February 17, 2009, the American Recovery and Reinvestment Tax Act of 2009 (ARRA; H.R.
1) was signed as P.L. 111-5. ARRA delayed by one year the implementation of the 3%
withholding tax on government contractors (Section 1511 of ARRA and Section 3402(t) of the
Internal Revenue Code) so that it would apply to payments made after December 31, 2011.23 The
Joint Committee on Taxation stated that the reason for the change was that
The Congress believes that the three-percent withholding requirement was not appropriately
targeted to the noncompliant taxpayers for whom it was originally intended and may impose
significant and costly administrative burdens on state and local governments.24
The IRS proposed regulations included a payment threshold of $10,000; thus payments less than
$10,000 would not be subject to withholding.25
Proposed Repeal Legislation in 112th Congress
In the 112th Congress, three bills, without a revenue offset, have been introduced that include a
provision to repeal the contractor withholding provision. On January 25, 2011, Senator David
Vitter introduced S. 89, Withholding Tax Relief Act of 2011. At its introduction, this bill had four
cosponsors and currently has eight cosponsors. Also on January 25, 2011, Senator Scott P. Brown
21 Internal Revenue Service, Safeguarding Taxpayer Data, Publication 4557, October 2008, p. 9.
22 Ibid.
23 Joint Committee on Taxation, General Explanation of Tax Legislation Enacted in the 111th Congress, JCS-2-11,
March 2001, p. 94.
24 Ibid., p. 95.
25 Internal Revenue Service, Implementation of Contractor Withholding Delayed One Year, p. 1, available at
http://www.IRS.gov.
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introduced S. 164, Withholding Tax Relief Act of 2011. At its introduction, this bill had one
cosponsor and currently has 13 cosponsors. On February 11, 2011, Representative Wally Herger
introduced H.R. 674, To Amend the Internal Revenue Code of 1986 to Repeal the Imposition of 3
Percent Withholding on Certain Payments Made to Vendors by Government Entities. At its
introduction, this bill had 10 cosponsors and currently has 147 cosponsors. In addition, on June 9,
2011, Senator Scott P. Brown proposed S.Amdt. 405 to S. 782, Economic Development
Revitalization Act of 2011.This amendment would repeal the withholding provision.
On August 23, 2011, House Majority Leader Eric Cantor issued a press release, which stated that
in September 2011, the House “will repeal the ‘3 percent withholding rule,’ which serves as an
unnecessary tax increase on those who do business with the government.”26
Implementation Delay by IRS
On May 5, 2011, the IRS issued final regulations (T.D. 9524) that delayed the implementation of
the 3% withholding tax on government contractors until January 1, 2013.27 These regulations
included a $10,000 threshold on payments from government entities to contractors and numerous
exemptions.28 In response to comments on initially proposed regulations, the IRS stated that
The Treasury Department and the IRS received numerous comments in response to the
proposed regulations, all of which were considered in formulating the final regulations.
Commenters generally expressed concerns about the administrative burdens of compliance
and the revenue effect on persons subject to section 3402(t) withholding. The final
regulations are intended to balance the legislative intent to construct a withholding and
reporting regime for payments by government entities for property and services … with the
goal of alleviating administrative burdens on both government entities required to withhold
and persons receiving payments subject to withholding where appropriate.29
The IRS is receiving public comments on its new proposed regulations.
On September 12, 2011, the IRS will hold a public hearing on proposed regulations (REG-
151687-10) on Section 3402(t) of the Code, which “provide guidance on whether section 3401(t)
withholding would apply to certain payments by government entities made on or after January 1,
2014, under existing contracts that are not materially modified.”30
26 House Majority Leader Eric Cantor, “Congressman Cantor Statement on Middle-Class Jobs and the Obama
Administration’s Underwhelming Regulatory Review,” Press Release, August 23, 2011, p. 1.
27 Internal Revenue Service, IRS Final Regulations (T.D. 9524) on Extension of Withholding to Payments by
Government Entities Under Tax Code Section 3402(t), May 5, 2011, 32 p.
28 Ibid., pp. 2-3.
29 Ibid., p. 2.
30 Internal Revenue Service, REG-151687-10, Notice of Proposed Rulemaking Withholding on Payments by
Government Entities to Persons Providing Property or Services, June 6, 2011, p. 1.
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Conclusions
The 3% withholding requirement on payments to contractors by government entities was passed
as a revenue offset, and its implementation has been delayed until January 1, 2013. This
requirement is intended to improve tax compliance. Widespread support exists for the repeal of
this 3% withholding requirement primarily because of concerns about its compliance costs. Some
members of both parties, public officials, business people, and representative of trade associations
have advocated its repeal.
There was also considerable public opposition to the implementation of a requirement that
payments of $600 or more by corporations be reported to the IRS, which was similar in intent to
the 3% contractor withholding requirement. On April 14, 2011, this 1099 reporting requirement
was repealed with the passage of the Comprehensive 1099 Taxpayer Protection and Repayment of
Exchange Subsidy Overpayments Act of 2011 (P.L. 112-9; H.R. 4).31
The IRS has attempted to address concerns about compliance costs by proposing a $10,000
threshold on government purchases from contractors and increasing the number of exemptions.
Furthermore, there is the possible issue of finding a replacement source of revenue. In the 112th
Congress, three bills, without a revenue offset, have been introduced to repeal the 3%
withholding provision, and a hearing was held. Currently, verifiable data does not exist to
objectively compare the costs with the benefits of implementing the 3% withholding requirement.
31 For an examination of this 1099 reporting requirement, see CRS Report R41400, Economic Analysis of the Enhanced
Form 1099 Information Reporting Requirements, by Mark P. Keightley; and CRS Report R41782, 1099 Information
Reporting Requirements and Penalties: Recent Legislative Activity, by Carol A. Pettit and Edward C. Liu.
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Appendix A. Tax Gap Data for 2001
Figure A-1. Tax Year 2001
(billions of dollars)
Source: U.S. Treasury, Internal Revenue Service, February 2007.
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Figure A-2. Individual Income Tax Underreporting Gap, 2001
Source: U.S. Treasury, Internal Revenue Service, February 2007.
Note: Based on updated estimates derived from the National Research Program underreporting compliance
study.
Table A-1. Individual Income Tax Underreporting Gap, 2001
Category
Tax Gap ($B)
NMPa
Items Subject to Substantial Information Reporting and Withholding
10.5
1.2%
Wages, salaries, tips
10.5
1.2%
Items Subject to Substantial Information Reporting
9.1
4.5%
Interest income
1.6 3.6%
Dividend income
1.1 3.7%
State income tax refunds
0.6
11.6%
Pensions & annuities
4.2
4.1%
Unemployment Compensation
a 11.1%
Social Security benefits
1.1
5.8%
Items Subject to Some Information Reporting
50.6
8.6%
Partnership, S-Corp, Estate & Trust, etc.
22.0
17.8%
Alimony income
a 7.2%
Capital gains
11.0 11.8%
Deductions
13.5 5.4%
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Category
Tax Gap ($B)
NMPa
Exemptions
4.2 5.4%
Items Subject to Little or No Information Reporting
110.1
53.9%
Form 4797 income
3.3
64.4%
Other income
22.6 63.5%
Nonfarm proprietor income
68.0
57.1%
Farm income
5.8 72.0%
Rents & royalties
13.4 51.3%
Total Statutory Adjustments
-3.0
-21.1%
Not Shown on Visibility Chart
17.1
26.3%
Credits
17.1 26.3%
Total
197.4 18.0%
Source: U.S. Treasury, Internal Revenue Service, February 2007.
a. NMP = Net Misreporting Percentage, the net amount of income or offset misreported divided by the
amount that should have been reported.
b. Less than $0.5 billion.
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Appendix B. JCT 2005 Option of Withholding on
Payments to Government
As stated in the introduction, the initial proposal to “Impose Withholding on Certain Payments
Made by Government Entities” was included in the JCT Options Report. The JCT description of
the proposal was as follows:
The proposal requires withholding on payments for goods and services made by all branches
of the Federal government and its agencies and all units of State and local governments,
including counties and parishes. Local governments with less than $100 million of annual
expenditures are excluded from the withholding requirement.
The rate of withholding is three percent on all payments, regardless of whether the payments
are for goods or services.
The proposal imposes information reporting requirements on payments that are subject to
withholding under the proposal but are not subject to information reporting under present
law.
The proposal does not apply to payments of wages or to any other payment with respect to
which mandatory (e.g., U.S.-source income of foreign taxpayers) or voluntary (e.g.,
unemployment benefits) withholding applies under present law. The proposal also does not
apply to the following: payments of interest; payments for real property; payments to tax-
exempt entities or foreign governments; intragovernmental payments; and payments made
pursuant to a classified or confidential contract (as defined in section 6050M(e)(3)).32
The JCT states that the proposal would apply “to payments made after the first December 31st that
is at least six months after the date of enactments.”33
In describing present law, the JCT indicated that “the Internal Revenue Code of 1986 (the Code)
requires employers to withhold income tax on wages paid to employees.”34 In addition, some
“nonwage payments are subject to mandatory or voluntary withholding.”35 The JCT also stated
that “Present law imposes numerous information reporting requirements that enable the Internal
Revenue Service (IRS) to verify the correctness of taxpayers’ returns.”36
In discussing its proposal, the JCT argued that withholding “provides taxpayers with a gradual
and systematic method to pay their taxes,”37 thus these taxpayers “are less likely to face a large
liability at the end of the tax year and have less motivation for underreporting their income.”38
The JCT also maintained that its proposal would reduce the number of collection points for
regular tax payments and thus improve tax compliance, although there would be a burden on
32 Joint Committee on Taxation, Options to Improve Tax Compliance and Reform Tax Expenditures, pp. 6-7.
33 Ibid., p. 7.
34 Ibid., p. 4.
35 Ibid.
36 Ibid., p. 5.
37 Ibid., p. 7.
38 Ibid.
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payors.39 The JCT stated that the flat 3% rate is “simple, easy to verify, and applicable to all
payees,”40 but “is likely to cause either overwithholding or underwithholding for some payees.”41
The JCT estimated that this proposal would “raise approximately $6.4 billion over fiscal years
2006 through 2014.”42
39 Ibid., p. 8.
40 Ibid.
41 Ibid.
42 Ibid., p. 9.
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Appendix C. GAO Studies of Tax Evasion by
Federal Contractors
GAO has found widespread tax evasion by federal contractors. Three of these GAO studies are
subsequently described.
2004 GAO Report on Department of Defense (DOD) Contractors
The JCT Options Report states that “a recent Government Accountability Office (GAO) study of
Department of Defense and IRS records showed that over 27,000 Federal contractors owed about
$3 billion in unpaid taxes as of September 30, 2002.”43 This GAO report also states that “we
estimate that DOD, which functions as its own disbursing agent, could have offset payments and
collected at least $100 million in unpaid taxes in fiscal year 2002 if it had fully assisted IRS in
effectively levying contractor payments.”44 In citing this report, the JCT was indicating
unsatisfactory tax compliance of DOD contractors, but GAO did recommend the partial
withholding of payments to contracts.
2007 GAO Reported Testimony on Federal Contractors
After the passage of the contractor withholding provision, on April 19, 2007, GAO’s Managing
Director, Forensic Audits and Special Investigations, testified at a hearing of a Subcommittee of
the House Committee on Oversight and Government Reform.45 GAO conducted an “in-depth
investigation of 122 federal contractors and in all cases found abusive and potentially criminal
activity related to the federal tax system.”46 This GAO investigation was preceded by three GAO
studies that “found thousands of federal contractors that owed billions of dollars of federal
taxes.”47
2011 GAO Report on Recovery Act Recipients
In April 2011, GAO reported that
At least 3,700 recipients of Recovery Act [American Recovery and Reinvestment Tax Act of
2009] contracts and grants—including prime recipients, subrecipients, and vendors—are
estimated to owe more than $750 million in known unpaid federal taxes as of September 30,
2009, and received over $24 billion in Recovery Act funds.48
43 JCT Options Report, p. 6.
44 U.S. Government Accountability Office, Financial Management: Some DOD Contractors Abuse the Federal Tax
System with Little Consequence, GAO-04-95, February 2004, p. 3.
45 United States Government Accountability Office, Thousands of Federal Contractors Abuse the Federal Tax System,
Statement of Gregory D. Kutz, Managing Director Forensic Audits and Special Investigations, before the
Subcommittee on Government Management, Organization, and Procurement; Committee on Oversight and
Government Reform, GAO-07- 742T, April 19, 2007, 15 pp.
46 Ibid., p. 2.
47 Ibid., p. 4.
48 United States Government Accountability Office, Recovery Act: Thousands of Recovery Act Contract and Grant
(continued...)
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Should the Withholding Requirement on Payments to Contractors Be Repealed?
Author Contact Information
James M. Bickley
Specialist in Public Finance
jbickley@crs.loc.gov, 7-7794
(...continued)
Recipients Owe Hundreds of Millions in Federal Taxes, GAO-11-485, April 2011, highlights page.
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