No public official wants to be a tax agent for somebody else. That's one reason states and localities object to a new federal law that threatens to turn them into de facto instruments of the IRS. But it's not the only reason.
As the result of a provision in the tax package enacted by Congress this spring, state and local governments that spend more than $100 million annually must withhold 3 percent of their payments to vendors for goods and services, then send the proceeds along to Washington. There are many problems with this provision. For one thing, it violates the Unfunded Mandates Act passed by Congress in 1995 and designed to prevent Washington from making state and local governments perform duties the feds aren't willing to pay for.
There will indeed be extra costs to states and localities from the new tax provision. Contractors, who are lobbying for the provision's repeal, warn that they'll have to raise the prices they charge public agencies in order to maintain their cash flow. Three percent may not sound like much, but in some cases it represents more than a contractor's entire profit from a government job.
There also will be administrative and software costs, although no one knows what those will amount to. The provision was slipped into the bill just prior to passage, leaving no time for tweaking or even careful study. The law is vague about issues such as how governments should report withheld amounts either to the IRS or to vendors, how often payments must be sent to Washington and what penalties would apply in cases of late payment or inaccurate reporting. It's also unclear how governments can withhold 3 percent of everyday purchases made with credit cards. "If we buy a box of pencils, do we pay 97 percent of the bill and withhold 3?" wonders Tim Firestine, finance director of Montgomery County, Maryland.
For all the headaches, the provision won't even generate that much money. The feds will see a one-time acceleration of income, but revenues will drop off as vendors start receiving refunds from previous years' overpayments. The provision is expected to generate $6 billion in 2011, the first year it will take effect, but only about $200 million a year after that. In essence, it's an accounting trick.
What's more, the whole thing could be unconstitutional, in light of a 1997 Supreme Court decision, in the case of Printz v. United States, holding that Congress could not force states and localities to perform administrative tasks for the federal government. "The objection is not frivolous on its face because of the Printz case," says William Van Alstyne, a constitutional scholar at the William and Mary School of Law. "To put it bluntly, if the feds want their tax, let them go and collect it."
Still, Van Alstyne predicts, the provision will likely survive court scrutiny should a challenge be filed. In that case, the debate over the withholding provision won't do much to clarify the constitutional relations between Washington and lower levels of government. What it will do is further poison those relations.