The Senate just agreed to repeal a controversial law opposed by state and local governments that would have required them to withhold 3 percent of certain payments owed to contractors and instead send the money to the Internal Revenue Service.
The withholding law, which was created five years ago but has never implemented due to several delays, was intended to help crack down on tax fraud. The withheld funds would have ultimately worked their way back to the businesses in the form of credits towards their federal taxes. The thinking was that if a business wanted to get fully paid, it would have to first fully pay its taxes.
But state and local leaders have argued for years that businesses would simply increase the cost of the goods and services they provide governments to avoid waiting for their full payments.
State and local government advocates also argued that the law was an undue burden, since they'd have to purchase and train staff on new accounting and purchasing software to incorporate the provisions of the law.
Massachusetts state Rep. Jay Kaufman, part of the National Conference of State Legislatures budgets and revenue team, called the 3 percent rule "intolerable and Clark Partridge, Arizona's state comptroller, called the 3 percent rule "inefficient, ineffective, and almost ridiculous."
"Really, there's no voice for it," Partridge told Governing.
Senators voted in favor of the repeal 95-0 this afternoon. The House passed the legislation last month on a 405-16 vote. Since the Senate repeal included an amendment that provides tax credits to companies that hire unemployed veterans, the legislation moves back to the House.
President Obama has endorsed the repeal as well and is expected to sign it into law after the House completes its work on the legislation. The withholding requirements would have taken effect Jan. 1, 2013.
Companies that do business with governments also opposed the law since they said it would disrupt their cash flow. The administration has pitched the repeal as a way to help the economy by preserving that cash flow so that it can be used to pay suppliers and create jobs.
Partridge said that some contractors -- including road builders and office supplies providers -- typically have profit margins of less than 3 percent. For those businesses, the law would have made it almost impossible for those companies to do business with governments.
The withholding rule was just part of a 2006 law that dealt with federal taxes, most notable by extending lower capital gains tax rates. The legislation that created the 3 percent rule was overwhelmingly supported by congressional Republicans and opposed by Democrats at the time. But the actual provision that called for the 3 percent withholding wasn't included in the original text of the legislation -- it was inserted during the conference committee.
Repealing the rule would reduce federal revenues by $11.2 billion from 2012-2021, according to the Joint Committee on Taxation. The bulk of those revenues would come in the first year of its implementation, from tax scofflaws who would initially start paying up as a result of the law's implementation
But the repealing the rule would also reduce federal costs by eliminating the federal agencies' need to modify their own accounting systems and preventing increased prices that vendors would charge the federal government. Those savings would amount to $7 billion over the same period, according to the Congressional Budget Office.
Cornelia Chebinou, Washington director of the National Association of State Auditors, Comptrollers and Treasurers, said that her members are "thrilled beyond belief" at the prospect of the law's repeal. Even though it wouldn't have taken effect until 2013, a handful of states including Arizona, Florida and Washington had already done some work to prepare for its implementation, she said.