DoD Releases Study on Three Percent Withholding Mandate

May 6, 2008

A new study released by the Department of Defense (DoD) estimates that the implementation cost of an impending law requiring federal, state, and local governments to withhold three percent of every payment made to government contractors will cost their department alone $17 billion over the first five years.

Specifically, the DoD report states:

DoD anticipates the costs for DoD to comply with section 511 will be significant - over $17 billion for the first five years. The estimated cost impact includes the costs for DoD to implement and manage section 511 within DoD and the additional costs escalation DoD will pay its contractors as a result of section 511. Further, DoD is concerned that section 511 may limit the number of companies willing to enter into the government market, thereby reducing competition and access to new technologies, and may cause other unintended consequences that are addressed in the report.

The three percent withholding mandate was included in the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222). Section 511 of the Act requires that government at all levels withhold three percent of payments for goods and services made to contractors. This law is slated to begin in 2011. Supporters in Congress said the three percent withholding mandate was necessary to collect taxes from government contractors that do not pay their taxes.

However, it now appears that the cost of implementing the new law, and for one government department alone, will greatly exceed the revenues that were anticipated from the mandate. The Joint Committee on Taxation (JCT) estimated that the three percent mandate on all levels of government—-federal, state and local-—would generate $7 billion over five years, with only about $1.1 billion being additional revenue and the rest being the "float" from advanced payment to the government.

This provision is going to cost federal, state and local governments billions of dollars in additional expenditures, and is not the best approach for identifying the small percentage of government contractors who do not pay, or underpay, federal taxes. Unless repealed, this law will be costly and harmful for small firms. Not only will it create serious cash flow issues for small government contractors, but it may also prevent many from bidding and working in the government procurement arena.

DoD’s cost impact estimate demonstrates the crucial need for Congress to repeal this law. NSBA strongly supports and urges Congress to quickly act on H.R. 1023 and S. 777, legislation to repeal the three percent withholding mandate.