The Internal Revenue Service (IRS) defines the gross tax gap as the difference between the aggregate tax liability imposed by law for a given tax year and the amount of tax that taxpayers pay voluntarily and timely for that year. It defines the net tax gap as the amount of the gross tax gap that remains unpaid after all enforced and other late payments are made for the tax year.
On January 27, 2005, the Joint Committee on Taxation (JCT) published a report titled Options to Improve Tax Compliance and Reform Tax Expenditures. The JCT report identified many options, including several to increase withholding. The first option was titled “Impose Withholding on Certain Payments Made by Government Entities.” The JCT argued that the IRS had extensively and successfully used withholding and information reporting to improve tax compliance. Furthermore, much empirical data supported the use of withholding and information reporting to reduce the tax gap. On May 17, 2006, President George W. Bush signed the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222), which included Section 511: “Imposition of Withholding on Certain Payments Made by Government Entities” (the JCT option). This section required 3% withholding on payments for goods and services to contractors made by all branches of the federal government and its agencies and all units of state and local governments, including counties and parishes. Local governments with less than $100 million of annual expenditures were excluded from the withholding requirement. The section also imposed information reporting requirements on payments that are subject to withholding. This section was a revenue offset and was scheduled to take effect on January 1, 2011.
Substantial opposition developed to this withholding provision. Critics argued that the public and private compliance costs were unacceptable, existing IRS enforcement tools were adequate, and privacy would be reduced. The American Recovery and Reinvestment Act of 2009 (P.L. 111-5) delayed the implementation of the withholding provision until January 1, 2012. On May 5, 2011, the IRS issued regulations that further delayed the implementation of the withholding provision until January 1, 2013.
In the 112th Congress, four bills to repeal the Section 511 withholding provision have been introduced: S. 89, S. 164, S. 1726, and H.R. 674. In addition, S.Amdt. 405 to S. 782, Economic Development Revitalization Act of 2011, would repeal the withholding provision.
The IRS has attempted to address concerns about compliance costs by proposing a $10,000 threshold on government purchases from contractors and increasing the number of exemptions.
On September 12, 2011, President Obama proposed the American Jobs Act of 2011, which included a section that would delay implementation of the withholding provision until after December 31, 2013. On September 13, 2011, at the request of President Obama, Senate Majority Leader Harry Reid introduced S. 1549, American Jobs Act of 2011.
On October 25, 2011, the Obama Administration endorsed H.R. 674 and H.R. 2576, which would modify the definition of income for determining eligibility for exchange subsidies, Medicaid, and the Children’s Health Insurance Program. H.R. 2576 would raise an estimated $13 billion over 10 years, which would offset the estimated $11.2 billion cost of H.R. 674. On October 26, 2011, the House voted to adopt a rule that combined H.R. 674 and H.R. 2576. On October 27, 2011, the House passed both H.R. 674 with a vote of 405 to 16 and H.R. 2576 with a vote of 262 to 157.
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