CQ TODAY ONLINE NEWS
June 1, 2011 – 7:51 a.m.
‘Tax Gap’ Laws Enacted, Only to Face Repeal
By Sam Goldfarb, CQ Staff
It is becoming a familiar exercise. Congress passes a law to strengthen tax enforcement. Then, realizing the law could hurt small businesses, lawmakers try to repeal it.
In each case, these repeal efforts — two of which have already been successful this year — are portrayed as individual fixes. But added up, they suggest lawmakers, under pressure from powerful small business groups, are becoming less enthusiastic about closing the so-called tax gap between taxes owed and collected — even as concern about the size of the federal budget deficit grows.
In the latest example of this trend, members of both parties are ramping up efforts to repeal a provision in a 2006 law (PL 109-222) that requires federal, state and local governments to withhold 3 percent of all payments to outside vendors for goods and services.
The provision effectively requires contractors to pay taxes more like individuals than other businesses, ensuring that taxes are collected and leaving it up to the IRS to decide whether the contractors are deserving of a refund at the end of the year.
In broad terms, the provision — a last-minute revenue offset for the extension of several tax cuts for businesses and investors — is an effort to reduce the tax gap, which by some estimates, runs about $300 billion annually.
Even though it has been on the books for several years, the withholding requirement has yet to be enforced. Originally designed to go into effect in 2011, Congress put off its implementation by one year as part of the 2009 stimulus law (PL 111-5). In a May 6 ruling, the IRS extended the delay through the start of 2013.
The ruling may have relieved pressure on Congress to pass another temporary delay. But it has not stemmed criticism that the withholding scheme will impose undue burdens on governments and contractors alike.
“Small businesses are the engine of private sector job growth. We don’t want any unnecessary impediments to their success, and that is why it is imperative to repeal the 3 percent [provision],” Rep. Gerald E. Connelly, D-Va., said May 26.
Speaking at a bipartisan news conference, Connelly was joined by several other lawmakers who delivered the same message. The coordinated communications effort also included a hearing earlier in the day by the Small Business panel’s subcommittee on contracting and workforce issues.
A Shift Toward Caution
Proponents of a repeal say they have momentum on their side. If they have their way on this latest issue, Congress could end up reversing course on three initiatives to reduce the tax gap in a single year.
In April, Congress passed legislation (PL 112-9) that repealed new information reporting requirements included in the 2010 health care law (PL 111-148, PL 111-152) as a revenue offset. The same legislation also repealed an information reporting provision in a 2010 law that extended tax and lending assistance to small businesses (PL 111-240).
In both cases, the reporting requirements were intended to ensure that small businesses provide an accurate assessment of their earnings to the IRS, yet were ultimately judged to be a costly administrative nightmare for those businesses.
‘Tax Gap’ Laws Enacted, Only to Face Repeal
With few lawmakers eager to raise taxes, these kinds of enforcement laws have been portrayed over the years as a relatively painless way to increase revenue and close the tax gap.
After Republicans tried to limit the powers of the IRS in the late 1990s, the pendulum swung back toward a desire to step up tax collection efforts in the mid-2000s.
Not all tax gap initiatives have faltered. As part of a 2008 housing assistance law (PL 110-289), for instance, banks are now required to report credit card transactions to the IRS, providing the agency with more insight into how much money businesses are making. The move is expected to raise approximately $9.5 billion over 10 years.
Still, lawmakers have consistently been frustrated by the fact that a large percentage of unpaid taxes are attributable to small businesses, which exert considerable influence in Congress.
Recently, Democrats in particular have been less likely to mention the tax gap when discussing politically feasible ways to raise revenue. They more often discuss a potential tax code overhaul that involves eliminating tax breaks but also lowering marginal rates for individuals and corporations. Republicans, meanwhile, have talked about decreasing funding for the IRS.
Making Their Case
Critics of the 3 percent withholding requirement for government contractors insist that it is a particularly misguided policy.
Contractors are concerned about the requirement’s administrative cost and impact on business cash flow, but they are especially annoyed that “there’s no relationship between the withholding of payments of goods and services received and tax liabilities that government contractors or others might have,” said Alan Chovtkin, executive vice president of the Professional Services Council, an industry group based in Arlington, Va.
Several bills that would repeal the requirement have been introduced this Congress, including one (
Herger said May 25 that he was in the process of finding out how much a repeal would cost. He expressed hope that the dollar figure would be relatively low despite previous estimates that it could reach as high as $10.9 billion over 10 years.
Several Democrats are cosponsors of Herger’s bill, including the Budget Committee’s ranking member,