A controversial federal policy that state and local governments say will increase costs -- and vendors fear will restrict cash-flow -- has been delayed by a year.

Now, governments won't have to comply with a rule forcing them to withhold 3 percent of the cost of purchasing goods and services until 2013.

The law, which would allow vendors to claim the withholding upon paying their federal taxes, is intended to encourage businesses hired by governments to comply with tax law.

In reality, state and local governments say the companies they do business with are more likely to simply increase their prices by 3 percent to avoid having to wait for the money. They also object to acting as tax collectors for the federal government. 

Additionally, they say it creates added burdens since they’ll have to restructure their computer systems and train and higher new accountants and auditors -- all at a time when money is short. The Defense Department alone has estimated it would cost more than $17 billion to implement the changes, due to modifications required to budgeting and accounts payable systems as well as increased staffing.

Those sorts of figures are what prompted the Congressional Budget Office to categorize the rule as an unfunded mandate.

The rules apply to all governments with more than $100 million in annual expenditures. The withholdings occur on payments of $10,000 or more.

“We just don’t feel like the benefit that’s perceived is outweighed by the costs,” says Cornelia Chebinou, who leads the D.C. office of the National Association of State Auditors, Comptrollers and Treasurers.

Vendors themselves oppose the 3 percent withholding as well. They view it as a way for the federal government to receive interest-free loans for more than a year at a time, and they expect it will hurt their cash-flow, which could be especially troubling for start-ups and companies that do large volumes of business with the public sector.

This is the second delay for the withholding law. It was originally scheduled to take effect at the start of 2011, but a section of the 2009 stimulus bill delayed its implementation to 2012. Chebinou says the delay is good news for state and local governments, but ultimately, they are pushing for the outright repeal of the rule.

Several bills have been introduced to repeal the requirement, including H.R. 674, which has more than 100 co-sponsors. The House Ways and Means Committee is scheduled to hold a hearing on the issue later this month.