On May 17, 2006, Senator Larry Craig introduced S. 2821, the Withholding Tax Relief Act of 2006, a bill that the Electronic Industries Alliance strongly supports. This important piece of legislation would repeal section 511 of the recently enacted Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222). This provision is a sweeping new requirement mandating a 3% tax withholding on all payments to contractors for goods and services provided to federal, state, and local governments.

This withholding provision is seriously flawed and should be reconsidered for the following reasons:

• It hits honest taxpayers in an attempt to get the tax cheats. Honest companies already pay their taxes on time. The provision forces contractors to provide the government an interest-free loan. It uses a sledgehammer to resolve tax-compliance problems caused by a small minority of government contractors.
• Fewer types of firms will be able to bid on government contracts, leading to higher costs to the government. The withholding provision is based on a company's revenue. Companies with tight margins or irregular cash flows would lose vital funds needed for day to-day operations and would be at a competitive disadvantage in the bidding process. Fewer competitive bids could translate to higher costs to the government.
• It increases the cost of doing business with all levels of government. Many contractors may have to take on higher levels of debt or equity in order to ensure regular cash flows necessary for operations. The cost of this increase in capital structure may be passed on to the government through increased price of goods and services and may ultimately be paid by the taxpayer.
• It is a $7 billion solution when the actual problem is only $200 million per year. The provision is aimed at collecting underreported tax revenues by government contractors, which would raise approximately $200 million a year. The large bulk of the estimated savings of $7 billion dollars is simply an accounting gimmick. The way the provision is set up, the government is paid for annual taxes twice in the first year (2011).
• It is potentially an unfunded mandate on state and local governments. Federal tax compliance enforcement is the function of the IRS, and this program would increase the costs to states significantly. The cost to administer programs could be substantial.
• This is the first time the federal law has imposed withholding a portion of revenues from a sales transaction between any entity and its customers for potential future tax liability. The new withholding provision is based on a company's revenue, not net income. Thus the arbitrary 3% withholding will not be a good indicator of tax liability – if it is an indicator at all. As a result, companies operating with high volumes and small profit margins would lose vital funds needed to operate day-to-day activities.