[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]


 
     DEFER NO MORE: THE NEED TO REPEAL THE 3% WITHHOLDING PROVISION

=======================================================================

                                HEARING

                               before the

               SUBCOMMITTEE ON CONTRACTING AND WORKFORCE

                                 of the

                      COMMITTEE ON SMALL BUSINESS
                             UNITED STATES
                        HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                              HEARING HELD
                              MAY 26, 2011

                               __________


                                [GRAPHIC] [TIFF OMITTED] TONGRESS.#13
                               

            Small Business Committee Document Number 112-017
          Available via the GPO Website: http://www.fdsys.gov


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                   HOUSE COMMITTEE ON SMALL BUSINESS

                     SAM GRAVES, Missouri, Chairman
                       ROSCOE BARTLETT, Maryland
                           STEVE CHABOT, Ohio
                            STEVE KING, Iowa
                         MIKE COFFMAN, Colorado
                     MICK MULVANEY, South Carolina
                         SCOTT TIPTON, Colorado
                         JEFF LANDRY, Louisiana
                   JAIME HERRERA BEUTLER, Washington
                          ALLEN WEST, Florida
                     RENEE ELLMERS, North Carolina
                          JOE WALSH, Illinois
                       LOU BARLETTA, Pennsylvania
                        RICHARD HANNA, New York
               NYDIA VELAZQUEZ, New York, Ranking Member
                         KURT SCHRADER, Oregon
                        MARK CRITZ, Pennsylvania
                      JASON ALTMIRE, Pennsylvania
                        YVETTE CLARKE, New York
                          JUDY CHU, California
                     DAVID CICILLINE, Rhode Island
                       CEDRIC RICHMOND, Louisiana
                         GARY PETERS, Michigan
                          BILL OWENS, New York
                      BILL KEATING, Massachusetts

                      Lori Salley, Staff Director
                    Paul Sass, Deputy Staff Director
                      Barry Pineles, Chief Counsel
                  Michael Day, Minority Staff Director


                            C O N T E N T S

                              ----------                              
                                                                   Page

                           OPENING STATEMENTS

Hon. Mick Mulvaney...............................................     1
Hon. Judy Chu....................................................     3

                               WITNESSES

The Honorable Wally Herger, U.S. House of Representatives, 
  Washington, DC.................................................     5
Mr. Curtis M. Loftis Jr., Treasurer, State of South Carolina, 
  Columbia, SC...................................................    10
Mr. Brian George, Deputy Director, Office of Cost, Pricing & 
  Finance, U.S. Department of Defense, Washington, DC............    11
Mr. Dave McDermott, Director, Standards and Compliance, Defense 
  Finance and Accounting Service, U.S. Department of Defense, 
  Washington, DC.................................................    13
Mr. Mike Murphy, President, Turner Murphy Construction, Rock 
  Hill, SC.......................................................    18
Mr. Ian Frost, Principal, EEE Consulting, Inc., Mechanicsville, 
  VA.............................................................    20
Mr. James M. Gaffney, Vice President, Goshen Mechanical Inc., 
  Malvern, PA....................................................    22
Ms. Kara M. Sacilotto, Partner, Wiley Rein LLP, Washington, DC...    24

                                APPENDIX

Prepared Statements:
The Honorable Wally Herger, U.S. House of Representatives, 
  Washington, DC.................................................    34
Mr. Brian George, Deputy Director, Office of Cost, Pricing & 
  Finance, U.S. Department of Defense, Washington, DC............    37
Mr. Curtis M. Loftis Jr., Treasurer, State of South Carolina, 
  Columbia, SC...................................................    44
Mr. Mike Murphy, President, Turner Murphy Construction, Rock 
  Hill, SC.......................................................    48
Mr. Ian Frost, Principal, EEE Consulting, Inc., Mechanicsville, 
  VA.............................................................    54
Mr. James M. Gaffney, Vice President, Goshen Mechanical Inc., 
  Malvern, PA....................................................    58
Ms. Kara M. Sacilotto, Partner, Wiley Rein LLP, Washington, DC...    71

Statements for the Record:
Airports Council International-North America.....................    91
American Farm Bureau Federation..................................    95
AICPA............................................................    97
American Healthcare Association..................................   101
American Logistics Association...................................   104
American Medical Association.....................................   110
American Trucking Association....................................   115
Associated Builders and Contractors Inc..........................   118
The Coalition for Government Procurement.........................   126
CTIA the Wireless Association....................................   129
The Computing Technology Industry Association....................   130
Construction Industry Round Table................................   136
Energy Systems Group.............................................   139
The Engineering and Utility Contractors Association..............   141
Florida Airports Council.........................................   142
Government Withholding Relief Coalition..........................   144
Miami-Dade Board of County Commissioners.........................   150
National Association of College and University Business Officers.   163
National Association of Manufacturers............................   165
National Association of Surety Bond Producers....................   169
National Association of State Auditors, Comptrollers and 
  Treasurer......................................................   171
National Defense Industrial Association..........................   177
National Electrical Contractors Association......................   181
National Roofing Contractors Association.........................   183
Orange County Board of Supervisors...............................   185
Riverside County Board of Supervisors............................   187
Santa Barbara County Board of Supervisors........................
The University of Illinois.......................................   188
U.S. Chamber of Commerce.........................................   191
Women Construction Owners & Executives, USA......................   196
Women impacting Public Policy (WIPP).............................   197
Ventura County Board of Supervisors..............................   198


     DEFER NO MORE: THE NEED TO REPEAL THE 3% WITHHOLDING PROVISION

                              ----------                              


                         THURSDAY, MAY 26, 2011

                  House of Representatives,
                       Committee on Small Business,
                 Subcommittee on Contracting and Workforce,
                                                    Washington, DC.
    The Subcommittee met, pursuant to call, at 10:00 a.m., in 
Room 2360, Rayburn House Office Building. Hon. Mick Mulvaney 
(chairman of the Subcommittee) presiding.
    Present: Representatives Mulvaney, West, Landry, Ellmers, 
Chu, Schrader, Kritz.
    Chairman Mulvaney. I am going to call this meeting to 
order. I thank all the witnesses for being here today. We look 
forward to everybody's testimony.
    I am pleased to spend this, which is my first hearing as a 
chairman of this Subcommittee, focusing on a government policy 
that is such a bad idea that when it was first enacted in 2006, 
Congress immediately delayed its implementation for five years. 
And when 2011 rolled around, Congress again delayed 
implementation of this 3 percent withholding requirement for 
another year. Now the IRS is causing further delays of the 
withholding requirements until 2013 because, as the IRS says, 
implementation of it would simply be too difficult, even though 
they have had six years to get ready for its implementation.
    Since no one seems too interested in implementing this 
policy, hopefully this hearing can build on this Congress's 
successful bipartisan repeal of the 1099 reporting requirements 
and serve as the starting point for a congressional action to 
repeal this 3 percent withholding requirement. The original 
intent of this withholding was to close the tax gap. In other 
words, 3 percent withholding was supposed to reduce the amount 
of taxes that were owed by government contractors but that went 
unpaid. So in that sense it is very similar to the 1099 
reporting requirements that we took up already earlier this 
year in this Committee and that this Congress subsequently 
repealed. Both the 1099 reporting and the 3 percent withholding 
requirements sought to close the tax gap through increased 
burdens on businesses of all types. But small business, as so 
often is the case, were hurt the most.
    Small businesses today already operate on thin profit 
margins with little room for any additional withholdings. As 
has been discussed in this Committee regularly this year, 
regulatory burdens fall particularly harshly on small business. 
And the 3 percent withholding requirement would be no 
exception. Many small business contractors, including those 
folks testifying here today, work for the government for less 
than a 3 percent profit margin. So the 3 percent requirement 
would force these contractors to wait until the end of the 
year, not only to get their profit but also to cover all of 
their costs.
    Also troubling is the possibility that government 
contractors will not have the funds to pay their subs during a 
project and will have to find outside financing to complete 
projects. And I think all of us who are related or involved in 
the small business community these days know how much fun it is 
these days to try and get outside credit.
    Even worse is the fact that implementing this 3 percent 
withholding requirement means treating all small businesses and 
their contractors with suspicion. Instead of rewarding those 
small businesses that choose to compete for and win contracts, 
the government essentially preaccuses them of cheating on their 
taxes. The government already requires all contractors to 
certify that they are in compliance with federal tax law. So 
one is left to wonder why we assume that they are going to 
break the law after they win a government contract.
    Furthermore, there is a burden--believe it or not, this is 
so often the case in what we do in Washington--there is 
actually a burden on state and local governments as well. I 
look forward to taking the testimony today of the state--of the 
treasurer from my home state of South Carolina as to the impact 
on the states. And there is a very real impact on the states. 
It is yet another unfunded federal mandate in this 3 percent 
withholding requirement.
    We also have witnesses from the Defense Department with us 
today to testify as to the great expenses that this withholding 
requirement will impose and how these expenses far exceed any 
projections for additional tax revenue. It makes absolutely no 
sense for the DOD to spend $17 billion over five years to save 
less than $6 billion on the first year and only $200 million a 
year after that. The Joint Committee on Taxation has actually 
predicted that after the first year, all increases in revenues 
to the government from this proposed 3 percent withholding will 
come from interest that the government earns on the 
withholding. It is essentially forcing small business and other 
contractors with the government to float the government an 
additional 3 percent. It is completely outrageous and I look 
forward to hearing from the small businesses today that will 
testify as to the other ways that the 3 percent withholding 
requirement will affect them.
    We have three really good panels today, but I also want to 
acknowledge all of the organizations that submitted information 
for the record. We have over 30 statements and I would love to 
read the list. There are about 35 organizations in here. I mean 
to slight nobody but this really is a who's who of American 
small business. Everybody who is involved in this industry from 
A to Z is just checked in on this 3 percent withholding bill 
and I really appreciate the effort that they have made. And 
this will be extraordinarily helpful to us as this Committee 
will--the testimony will be today in pushing this initiative 
further through this Congress.
    Here is how we are going to work it today, folks. 
Ordinarily--oh, by the way, I ask unanimous consent that those 
be added to the record. And hearing no objection, it is so 
ordered.
    Here is how we want to do it today before I recognize the 
ranking member. And I apologize for speaking very quickly. It 
is not something ordinarily we do in South Carolina, but I have 
been informed that we may begin voting today as early as 11:30. 
I have been through enough hearings in Washington to recognize 
what happens when Subcommittee hearings are interrupted by 
votes, which is that nobody comes back afterwards. And 
especially today, given the number of amendments that we may be 
taking up on the floor, these votes may take well over an hour 
and maybe possibly two or three. So in the interest of time we 
will be asking folks to try and stick to the five-minute limit. 
And we will not engage in as much back and forth as you 
ordinarily might hear from us because we do want to make sure 
everybody gets a chance to get their statements in the record.
    So with that I recognize the Ranking Member Chu for her 
opening statement.
    [The information follows:]
    Ms. Chu. Thank you so much. I thank the gentleman from 
South Carolina, Chairman Mulvaney, for yielding.
    Today's hearing will focus on an issue that could impact 
millions of small businesses across the country contracting 
with the federal government. The United States Federal 
Government is the largest purchaser of goods and services in 
the world purchasing more than $425 billion per year. And small 
businesses play an integral role in meeting the needs of the 
federal government. In fact, federal agencies are required to 
establish contracting goals with a total of 23 percent of all 
government buying targeted to small firms.
    Therefore, any policy that could hamper the ability of 
small firms to do business with government must be looked at 
carefully. While there is often little agreement in Congress on 
many policies, there is bipartisan consensus that the issue of 
the 3 percent withholding requirement on all government 
contracts needs to be addressed. The original intent of the law 
was to prevent government money from going to individuals and 
companies with outstanding tax debts. However, as the law was 
written, the withholding will apply to virtually all 
contractors, even if they do not have a tax liability or other 
delinquency.
    Like the 1099 filing requirement that was recently repealed 
by Congress, the reasoning behind the 3 percent withholding 
requirement was to increase tax compliance and reduce the tax 
gap. However, this is another instance where a broad brush 
approach has harsh consequences for small firms. First, 3 
percent of a contract often represents the estimated profit or 
operating cash flow for small firms in the construction 
industry. This money could be used by contractors to compensate 
for material costs, supplies, and other operating expenses. The 
withholding requirement will force many small firms to divert 
funds needed to complete a contract, creating cash flow 
problems. At a time when small firms are still having a hard 
time accessing credit from banks, laws like this create another 
barrier for small firms seeking to do business with the 
government. The new mandate will have an adverse effect on the 
smallest of firms since many prime contractors may be compelled 
to pass the costs associated with the 3 percent withholding 
requirement to their subcontractors.
    Additionally, government agencies have voiced a concern 
that administering the 3 percent withholding requirement will 
create more costs than benefits. The Department of Defense 
issued a report that implementing this could cost $17 billion 
for the first five years alone, far outweighing the revenue 
brought in. State and local governments have also actively 
fought to repeal the 3 percent withholding since it represents 
an unfunded mandate at a time when state and local budgets are 
stretched to the limit. In fact, many state and local agencies 
do not have the internal processes and systems to withhold 
payments and track them. Although the implementation of this 
law has been delayed, now is the time to fully repeal this 
onerous provision.
    At a time when America needs to promote economic activity, 
the 3 percent withholding only hampers transactions between 
businesses and the government. If Congress does not act, 
businesses will face additional paperwork every time they sell 
goods and services to the government. As the economy continues 
improving, small businesses need to focus on what they do best, 
developing innovative new services, bringing additional 
products to market, and creating jobs. And while it is 
important to enact policies that ensure taxpayers are paying 
their fair share of taxes, overreaching policies do not serve 
that purpose. There is bipartisan support for this repeal and 
doing so will allow small firms to continue to perform quality 
work on behalf of the public.
    With that I would like to welcome Congressman Herger to the 
Committee, as well as the witnesses who have taken time from 
their busy schedules to testify here today.
    I yield back.
    [The information follows:]
    Chairman Mulvaney. Thank you, Ms. Chu.
    Very briefly, just for the folks who have gathered here and 
for the folks especially who are here for the first time, 
including the folks who are testifying for the first time, why 
are we here? We are here to sort of take the testimony and 
build a record. It is the job of this Committee to take 
information about Mr. Herger's bill that we will hear about in 
a few minutes and then make recommendations and report back to 
the Ways and Means Subcommittee with hopes that they will then 
approve this bill, bring it to the floor so that we can vote on 
it, and then send it to the Senate.
    Towards that end, you saw the book that we have. That is 
part of the record. The other record will be made up today by 
the testimony of the three different panels.

  STATEMENTS OF WALLY HERGER, U.S. HOUSE OF REPRESENTATIVES; 
  CURTIS M. LOFTIS, JR., TREASURER, STATE OF SOUTH CAROLINA; 
  BRIAN GEORGE, DEPUTY DIRECTOR, OFFICE OF COST, PRICING AND 
 FINANCE, U.S. DEPARTMENT OF DEFENSE; MIKE MURPHY, PRESIDENT, 
TURNER MURPHY CONSTRUCTION, ASSOCIATED GENERAL CONTRACTORS; IAN 
  FROST, PRESIDENT, EEE CONSULTING, INC., AMERICAN COUNCIL OF 
  ENGINEERING COMPANIES; JAMES M. GAFFNEY, PRESIDENT, GOSHEN 
   MECHANICAL, INC., QUALITY CONSTRUCTION ALLIANCE; KARA M. 
              SACILOTTO, PARTNER, WILEY REIN, LLP

    Chairman Mulvaney. And our first panelist is our colleague, 
Congressman Wally Herger. He serves on the House Committee on 
Ways and Means. In that role, his primary legislative concerns 
include security economic growth and encouraging innovation and 
entrepreneurship by reducing the tax burden on America's 
families and small business. He is also interested in making 
government run more efficiently by reducing federal regulatory 
burdens and spending and responsibly reforming entitlement 
programs to make them sustainable and ensure that they will be 
around for the future generations.
    Congressman Herger is the sponsor of H.R. 674, of which I 
am proud to be a co-sponsor, and which seeks to repeal the 3 
percent withholding provision which is the bill we are here 
today to discuss.
    Congressman, welcome. And we look forward to your 
testimony.

                   STATEMENT OF WALLY HERGER

    Mr. Herger. Chairman Mulvaney, Ranking Member Chu, and 
members of the Subcommittee, thank you for holding this hearing 
on the need to repeal the 3 percent withholding tax on 
government contracts.
    As someone who has been passionately opposed to this tax 
from the day it was first signed into law, I am encouraged by 
the Committee's interest in this issue. Section 511 of the Tax 
Increase Prevention and Reconciliation Act of 2005 requires 
government agencies at all levels--federal, state, and local--
to withhold 3 percent of payments for goods and services 
effective in 2012. The Internal Revenue Service has recently 
issued regulations delaying this requirement until January 1, 
2013, but agencies and businesses must still plan for it to 
eventually take effect. The breadth of this 3 percent 
withholding tax is truly astounding. It affects everyone, from 
the manufacturer who builds tanks for the Army, to the nursing 
home that cares for poor seniors on Medicaid, from the 
construction workers who repair roads and levees, to the 
commissaries that sell groceries to families on military bases.
    As the members of this Subcommittee are well aware, small 
businesses are the lifeblood of our economy. I come from a 
small business background myself, so I have firsthand knowledge 
of how our country's entrepreneurs and job creators are 
burdened by a complex tax code and cumbersome regulations. If 
the 3 percent withholding tax is permitted to go into effect, 
it will only add to that burden. Many businesses that contract 
with the government operate on very narrow profit margins, 
often less than 3 percent. As a result, this tax will create 
serious cash flow problems for small businesses.
    Today our economy is in poor condition. The stock market 
may have improved from the low point of the recession but for 
most Americans the signs of recovery have been few and far 
between. Millions of people are still without work. In my 
Northern California congressional district, some counties have 
more than 20 percent unemployment. Government regulations and 
taxes that were a bad idea even in happier times are absolutely 
disastrous when our economy is struggling to recover and create 
jobs.
    In addition to its impact on small businesses, the 
recession has also taken a toll on state and local government 
finances. Cities, counties, and states across America are 
struggling to balance the budget without raising taxes or 
slashing vital services. The 3 percent withholding tax would 
worsen this fiscal crisis by creating new administrative costs 
and potentially raising procurement costs for state and local 
governments.
    Supporters of the 3 percent withholding requirement have 
billed it as a tax-compliance measure. Yes, it is a problem 
when government contractors do not pay their taxes. But instead 
of slapping a new tax on everyone, a tax that will actually 
cost the government more to collect than it raises in revenues, 
we could simply stop awarding government contracts to people 
who cheat on their taxes. In fact, since the 3 percent 
withholding provision became law, OMB and Treasury Department 
have announced several initiatives to do just that. Hopefully, 
these new compliance measures will provide the final push for 
Congress to repeal 3 percent withholding once and for all.
    Again, I appreciate the opportunity to testify this 
morning, and I look forward to working with the chairman and 
other members of this Committee to move ahead with repeal.
    [The statement of Mr. Herger follows:]
    Chairman Mulvaney. Thank you, Mr. Herger. Very briefly, I 
have one question. It just came up and was presented to me a 
day or two ago when I was talking about this bill.
    And I think there was a GAO report that came out last week 
or early this week that indicated that there were as many as 37 
recipients of grants or contracts under the Recovery Act who 
owed taxes. Thirty-seven hundred folks who got government 
contracts or government grants under the stimulus program 
actually owed taxes. And I think the total amount that they 
estimated that they owed was $750 million. So the question was 
put to me and I will put it to you, which is against that 
background, why is this bill still a really good idea?
    Mr. Herger. Well, again, I do not think it is--first of 
all, everyone should be paying their taxes and we should be 
moving in a judicious way that makes sense to ensure that those 
who are not paying their taxes do. We might point out this is a 
small percentage that do not pay their taxes. We should not be 
penalizing the masses who do pay their taxes just for those who 
are not. I believe the government has taken steps to correct 
this. We need to take further steps. As a matter of fact, one 
quarter of those who did not pay their taxes we were able to 
find out and we were able to deal with and again, there are 
more judicious ways to do this than penalizing everyone.
    Chairman Mulvaney. Thank you, Mr. Herger. I yield now to 
Ms. Chu for any questions.
    Ms. Chu. Congressmember Herger, the repeal of the 3 percent 
withholding seems to have broad bipartisan support. It is clear 
that both parties want this fixed and small businesses want it 
done quickly. And the title of this hearing is Delay No More: 
Repeal. So when does your Committee anticipate marking up this 
bill or taking any other substantive action to repeal it?
    Mr. Herger. Chairman Camp, chairman of the Ways and Means 
Committee, has indicated his support. As you know, there is a 
lot going on in Ways and Means now with health care and a 
number of other areas. So we are--the fact that we are having 
this hearing today, the fact of the growing support around the 
nation I think helps put this more to the importance of 
bringing this sooner than later that we will have a markup on 
it in Ways and Means.
    Ms. Chu. Chairman--well, I actually have another question.
    Congressman Herger, we know that when companies do not pay 
their fair share of taxes it creates an unlevel playing field. 
I believe this measure was enacted as a tax gap proposal. Do 
you believe that there are measures that could be put in place 
to close the tax gap and help level the playing field for 
honest small businesses? If so, could you share some of those 
with us?
    Mr. Herger. Absolutely there are. And I think we are moving 
towards it now. As I mentioned, one-quarter of that amount that 
we indicated that had not been paid, by new measures that have 
been put into place we have already been able to determine 
those one-quarter. And we need to continue taking stronger 
measures. But a measure like the 3 percent, that penalizes 
everyone. The masses who are paying their taxes is not the way 
to go about this and we need to keep the pressure on so that 
everyone pays their taxes.
    Ms. Chu. Thank you. I yield back.
    Chairman Mulvaney. Thank you. I recognize the gentleman 
from Florida, Mr. West, for up to five minutes.
    Mr. West. Thank you, Mr. Chairman.
    My colleague, Mr. Herger, I only have one question. You 
know, having served 22 years in the United States military and 
retiring thereof, and of course when you talk about the effect 
upon commissaries and exchanges, do you see that possibly with 
this 3 percent withholding tax, that the Department of Defense 
may then push the cost against the individuals who are using 
the commissary and exchanges to include our retiree community?
    Mr. Herger. I do not think there is any doubt about that. 
This will increase the cost to commissaries and I am sure that 
this cost--it would be very difficult. As you know, the 
military is running very frugally now and I think it is very 
likely that these costs will be passed on. And therefore, our 
men and women in the military will have to pay more than they 
would otherwise.
    Mr. West. Thank you, Mr. Chairman. I yield back.
    Chairman Mulvaney. Thank you. I recognize the gentleman 
from Louisiana, Mr. Landry, for up to five minutes.
    Mr. Landry. Mr. Herger, I am just curious--whose brainchild 
was this in 2005? I know this--it originated in the Senate. It 
was something that was tagged onto a legislation in the latter 
hours going through. Part of an omnibus pay-for. You do not 
know who in the Senate----
    Mr. Herger. Well, I think it is public knowledge who has 
been supporting this.
    Mr. Landry. I do not know. That is why I am asking.
    Mr. Herger. It came through the Finance Committee of the 
Senate.
    Mr. Landry. Because it just seems to me that this 
automatically increases government's cost. I mean, companies 
who are operating on thin margins and need cash flow, when they 
are going to bid on these projects they are going to have to 
factor this in. So that just increases our costs. I am just 
trying to figure out as a freshman here how people come up with 
ridiculous legislation like this.
    Mr. Herger. Well, giving them the benefit of the doubt I 
have to believe that it was well meaning. I am sure they 
thought, well, we will just withhold 3 percent. That way we 
will make sure that we collect it. But again, I think it is 
obvious as we look at it and analyze it, it was something that 
was not well thought out. And certainly as we are hearing from 
our small business people. And not just the small business, but 
as was mentioned, just the Department of Defense. It was 
estimated it was going to cost them an additional $17 billion 
to implement this. So I think as we analyze it, something that 
might have started off well meaning, certainly we can see the 
repercussions are very, very derogatory and negative and 
something we need to correct sooner than later.
    Mr. Landry. But what I do not understand is they must have 
known it would have had some sort of impact because they kicked 
the can down the road to 2010. And then of course they realized 
that it was a problem and they kicked it down again and now it 
is in our lap. I am trying to figure out, you know, I guess 
what they think about when they pass legislation like this. I 
know it is like a feel-good piece of legislation telling the 
American people that, you know, we are going to do something 
for tax cheats when really what we should be doing is letting 
the IRS go in and enforce those provisions. So I was just--I 
was trying to get a little bit--I know you have been here for a 
long time and so I am trying to get some wise advice, I guess, 
today.
    Mr. Herger. Mr. Landry, I think the wise advice is coming 
from new members like yourself that have been out in the real 
world. I think the bottom line is as has happened so often, 
well meaning legislation many times has not been thought out 
and how it really affects regular people that are out in 
America trying to make a living for their family, trying to 
grow their business and hire new people.
    This is certainly one of those, I would say, pieces of 
legislation that was intended to collect taxes that were not 
being paid that I believe was not thought through very well at 
the time. It might have been--I am sure it was well meaning. I 
have to believe it was well meaning at the time, but we can 
certainly--what is important is that at this time we can see it 
is not working. It is very harmful to small business at a time 
when we need to be growing jobs and expanding our economy. This 
is the type of legislation that is working exactly in the 
opposite direction.
    Mr. Landry. Well, I want to thank you because that is why I 
came to Congress, to vote on legislation just like this. So I 
certainly hope that Ways and Means takes it up.
    Thank you. I yield back.
    Chairman Mulvaney. Mr. Herger, thank you again. I 
appreciate you coming in, and thank you for offering the bill 
this year.
    Mr. Herger. Thank you. And again, I want to thank this 
Committee. I want to thank you, Mr. Chairman, who also is a new 
member. I compliment you for being chairman.
    Chairman Mulvaney. And a small businessman, so I really 
appreciate it.
    Mr. Herger. A small business one. And this is the type, as 
well as Mr. West and some others, this is the time to correct 
this. Thank you for your emphasis. Working together we will 
repeal this.
    Chairman Mulvaney. Thank you, Mr. Herger.
    I will ask the Committee to go ahead and begin to seat the 
second panel if we can.
    And while the second panelists are coming up, a word to all 
of the panelists. There are those little crazy lights in front 
of you. They are green, yellow, and red. It will be green for 
the first four minutes, yellow for the second minute, and then 
turn red. We usually do let you go a few minutes beyond if you 
like. Today we would like, again, to try and keep as close as 
we can because of the time constraints that we are under. If 
you start to hear this tapping motion, that means that we are 
asking you to please wrap things up as quickly as you possibly 
can.
    The second panel has two government witnesses. First, I am 
pleased to welcome Mr. Curtis Loftis, Jr. Mr. Loftis was 
elected treasurer of the great state of South Carolina in 
November of last year. In this role, Mr. Loftis is responsible 
for the investment, cash management, and safekeeping of the 
state's general and restricted funds, and also the assets of 
the South Carolina Retirement Systems. He also serves as the 
vice chairman of our State Budget and Control Board, which 
handles the State Procurement programs, state insurance, the 
Budget office, the State Auditor's office, State Human 
Resources office, the General Services offices, the Budget 
office, and the State Technology office. Prior to running for 
office, Mr. Loftis owned and operated a very successful small 
business in West Columbia. Welcome Mr. Loftis.
    I would also like to welcome at the same time our second 
witness, Mr. Brian George. He is the deputy director of the 
Office of Cost, Pricing, and Finance, Defense Procurement and 
Acquisition Policy, where he is the lead for reinvigorating 
costs and pricing skills within the Defense Department and 
advises the director on issues relating to contract costs, 
pricing, and finance.
    He is accompanied by Mr. David McDermott, the director of 
Standards, Compliance, Defense Finance, and Accounting Service. 
Mr. Dermott is responsible for developing finance and 
accounting goals and standards and analyzing operational 
results. Mr. George is going to provide testimony on behalf of 
the Defense Department and answer questions related to those 
issues. Mr. McDermott will not be testifying but is also 
available to answer questions as well, especially regarding the 
Defense accounting system. Gentlemen, thank you.
    We will go ahead and recognize Mr. Loftis for his comments.

               STATEMENT OF CURTIS M. LOFTIS, JR.

    Mr. Loftis. Thank you, sir. Mr. Chairman, members of the 
Committee, I am honored to be here today.
    Mr. Chairman and members of the Committee, I am very 
honored to be here today. I urge the repeal of the federal 3 
percent withholding provision. Section 511 imposes an arduous 
and costly mandate. It will unfairly penalize state and local 
governments and businesses that run honest, taxpaying 
companies. The impact and unintended consequences of this 
requirement on both government and private enterprise are 
serious. Expensive implementation costs come during a time of a 
weak financial recovery. Compliance with this recovery will 
prove oppressive, deprive entries, and will definitely cost us 
jobs. Of course, the taxpayer will have to pay the burden of 
this plan.
    I am the Treasurer of South Carolina, but I am also a small 
businessman. I have three dozen employees in Columbia, so I 
have to take these issues seriously. I would like to share with 
you how I see the impact of all of this. First, let us look at 
the negative impacts on the state and local governments. The 
provision imposes administrative costs and recording 
requirements for implementation and maintenance of the vendor 
tax withholding and the actual payment of the tax on behalf of 
the vendors to the IRS. It will be an administrative nightmare. 
There will be major modifications to accounting systems and 
other administrative processes. The manpower and dollar costs 
of the provisions for the local and state government access 
across the country will be astronomical. Coupled with 
administrative costs, many believe the vendors will increase 
their prices to government in order to compensate for this 
penalty tax. Again, as a result the taxpayers will pay more.
    The withholding law will negatively affect governments' 
budgets at a time when every dollar counts. Smaller units of 
governments may not be able to sustain the burden of 
administering this program. Federal tax enforcement is the 
function of the IRS and the federal government, not of the 
state and local governments. The 3 percent withholding 
penalizes all tax-compliant businesses. It forces them to 
provide the federal government with an interest-free loan by 
requiring advanced payment on taxes which may not even be due 
at the end of the year. The withholding is based on gross 
revenues from contract payments and they may have no 
relationship to taxable income. Firms with tight profit margins 
will lose funds necessary for vital operations. Cash flow may 
be damaged to the point that some companies withdraw from doing 
business with the government altogether. Business expansion 
could be halted or deferred. Additional cash flow constraints 
can push some companies out of business altogether.
    I am particularly concerned about what Section 511 does to 
my home state. Small business is essential to the well-being of 
South Carolina. In 2008, there were 364,000 small businesses in 
South Carolina, and they account for 50 percent of the private 
sector jobs. Small firms made up 97 percent of South Carolina 
employers. Small business is the engine that drives South 
Carolina's economy. The success of the small business sector is 
critical to our economic recovery. The withholding requirement 
will reduce the amount of capital available for payroll, new 
business investment, and daily expenses. South Carolina's 
unemployment rate in April placed us at the ninth highest in 
the country.
    Mr. Chairman, we need jobs, not more regulation. We need 
capital, not more taxes. There is a saying, ``an error we 
refuse to correct has many lives.'' I believe the negative 
consequences of this mandate will snowball, so I strongly urge 
the members of this Committee and the House to take action as 
quickly as possible to repeal Section 511. I would like to 
commend Representative Herger for his work on H.R. 674, and 
also Mr. Chairman, I would like to give a special thank you to 
my fellow South Carolinian for allowing me to come and speak to 
you on behalf of the state and local governments in South 
Carolina.
    [The statement of Mr. Loftis follows:]
    Chairman Mulvaney. Thank you, Mr. Loftis. I appreciate that 
very much.
    Mr. George, if you will go ahead and give your testimony, 
then we will ask questions of the panel as a group.

                   STATEMENT OF BRIAN GEORGE

    Mr. George. Chairman Mulvaney, Congresswoman Chu, and 
distinguished members of the Subcommittee on Contracting and 
Work Force. I welcome the opportunity to appear before you 
today to discuss the Department's Report to Congress.
    Our 2008 report addressed the impacts of compliance with 
Section 511 of the Tax Increase Prevention and Reconciliation 
Act of 2005. My name is Brian George, and I serve as the Deputy 
Director in the Office of Cost, Pricing and Finance for the 
Defense Department. My organization prepared the 2008 report.
    With me today is Mr. David McDermott, the Director for 
Standards and Compliance at the Defense Finance and Accounting 
Service. He is responsible for overseeing the Comptroller's 
implementation of Section 511. Our report was submitted in 
response to the House's Committee and Armed Services' request 
that the Department assess the impact of compliance with 
Section 511. As you are well aware, Section 511 requires 
federal, state, and local governments to withhold and remit to 
the IRS 3 percent of payments made to contractors for goods and 
services. At the time the report was prepared, the IRS had not 
developed regulations to implement the Section 511 withholds. 
As a result, our report was based on a number of assumptions 
regarding how the IRS would implement the withholds.
    We originally estimated for implementation and then 
management for the first five years, $17 billion to comply with 
Section 511. This included about $4 billion related to the 
Department losing the use of the commercial purchase card and 
about $13 billion related to contractors' costs. The Department 
still expects the impact to comply with Section 511 to be in 
the billions of dollars but lower than the original estimate. 
It will be lower since a few of our assumptions in 2008 
differed from the final IRS regulations published this month. 
Let me discuss just two of those assumptions.
    We correctly assumed the IRS would not allow companies to 
offset the amounts withheld under Section 511 against their 
estimated quarterly income or payroll tax payments. The report 
expressed our concern that contractors properly paying their 
tax obligations will experience cash shortages equal to the 
amounts withheld until the amounts are recovered through the 
normal federal income tax process. However, we incorrectly 
assumed that the IRS would not exclude third-party payments, 
such as the commercial purchase card, from the 3 percent 
withhold. Our report stated that if third-party payments were 
not excluded, DOD would lose its ability to use the commercial 
purchase card. This would occur because the Department would 
not be able to execute withholds against those payments. Almost 
$8 billion of our estimate related to that impact. However, in 
its final rule, the IRS indicated that it may require 
withholding of such transactions in the future.
    Although the costs for DOD and our contractors to implement 
Section 511 will be less than we estimated three years ago, we 
still expect the impact to be significant. The Department is 
concerned that Section 511 will restrict the available cash of 
tax-compliant companies, especially small businesses and we are 
also concerned the Department may lose its use of the 
commercial purchase card in the future.
    This concludes my verbal statement. Mr. McDermott, I will 
be happy to address your questions and request that my written 
statement be entered into the record.
    [The statement of Mr. George follows:]
    Chairman Mulvaney. Thank you, gentlemen. And for all of the 
witnesses, your witness statements have already been entered 
into the record.
    Very quick question. You hit on something, Mr. George, that 
caught my attention, which is the $17 billion was roughly 
broken into two pots--$4 billion for this purchase card but $13 
billion for increased contractor costs. Tell me a little bit 
more about that. How did you all arrive at the number? What is 
driving that number?
    Mr. George. I will be glad to tell you about that.
    Of the $13 billion for the contractor, about $4 billion 
related to the purchase card, $9 billion related to 
implementation costs and re-incurring costs to implement this 
rule.
    Chairman Mulvaney. So to implement this particular 
regulation would cost just the Department of Defense--not the 
whole federal government, just the Department of Defense--$9 
billion?
    Mr. George. Well, the $9 billion----
    Chairman Mulvaney. Million or billion, sir?
    Mr. George. Billion.
    Chairman Mulvaney. Okay.
    Mr. George. Of the $9 billion, most of that is contractors' 
cost.
    Chairman Mulvaney. For them to implement it?
    Mr. George. That is correct.
    Chairman Mulvaney. Which is then passed on to us through 
higher costs.
    Mr. George. It could be passed on to us. That is correct.
    Chairman Mulvaney. Exactly. Thank you, Mr. George.
    Mr. Loftis, do we--very briefly, do we withhold in the 
state of South Carolina in a system similar to that? Do we 
withhold for taxes?
    Mr. Loftis. No, sir. We have a limited program for out-of-
state contractors who do work with the state but it is a state 
tax. Nothing for the federal government.
    Chairman Mulvaney. So you would have to completely overhaul 
your entire accounting system at the state, local, and county 
level in order to implement this regulation.
    Mr. Loftis. That is right. There are multiple agencies now, 
like the Department of Revenue, the Treasurer's Office, 
Comptroller General, and others, the Budget Office, who are 
working on this all without any certainty of where the program 
is going. So it equates to a lot of wasted man-hours so far.
    Chairman Mulvaney. I recognize Ms. Chu for as much time as 
she needs.
    Ms. Chu. Mr. George, we have talked about the 
implementation costs for the DOD. Are you aware of any other 
agencies that have conducted similar studies that analyze their 
costs in complying with the 3 percent law?
    Mr. George. No, ma'am. I am not familiar with any other 
agencies.
    Ms. Chu. DOD, of course, is so large. Would you anticipate 
that it might cost even more for smaller agencies to implement 
such a withholding?
    Mr. McDermott. I would be reluctant to answer for any other 
agencies, Congresswoman Chu.
    Ms. Chu. Well, then, Mr. McDermott, let me ask. The 
original intent of the 3 percent withholding was to stop tax 
cheats. It is a laudable goal because there are many tax-
compliant businesses that are competing with these tax-avoiding 
businesses. However, the 3 percent withholding provision will 
make honest taxpayers face these enormous burdens under this 
law. As the Director on Standards and Compliance, what other 
less burdensome methods are available to the federal government 
to ensure that government contractors are also good taxpayers?
    Mr. McDermott. Congresswoman Chu, I can speak to what we do 
today to ensure that we are working with companies that are not 
delinquent on their taxes. In the beginning of the contracting 
process, the contracting officers do check to see with the 
Contractor Registration System to see if a contractor has been 
disbarred or for some reason has some delinquency or other 
reason that they would not do work with the government. For the 
agency that I work with, we participate in a program called the 
Treasury Offset Program, where we trade information with the 
Department of the Treasury, approximately 13,000 payments a day 
that we share information with the Treasury on that the 
Treasury looks to see if there are any delinquencies either for 
taxes or other government debts. And if there is such a debt, 
we offset the amount up to the amount of the payment that we 
are looking at at that particular time. During fiscal year 
2010, we were able to liquidate 3,500--approximately 3,500 
debts. That is our main way of ensuring that we assist the rest 
of our government partners in liquidating debts to include tax 
debts.
    Ms. Chu. How do you assess the success of this?
    Mr. McDermott. We believe that it is a successful program 
by virtue of the fact that we did find approximately 3,500 
debts working with the Treasury, and those were funds that were 
recouped to the government that did not go to the contractor 
where we would have to go after them after we had made that 
payment.
    Ms. Chu. Mr. George or Mr. McDermott, small businesses 
provide the federal government with goods and services in a 
wide range of services. Examples include construction 
contracts, retail, and information technology services. From 
the DOD's perspective, are there any industries that would be 
disproportionately affected by the 3 percent withholding 
requirement?
    Mr. George. Ma'am, not from my perspective. I think small 
businesses would be hurt perhaps harder. And that is 
speculation on my part. And let me just go back to the other 
question you asked Mr. McDermott. One thing that has happened 
on the contracting side since this law is passed is that 
contractors have to certify that they are not tax delinquent to 
get a government contract. So that is a significant step they 
have to go through now to get a contract. It did not happen 
before.
    Ms. Chu. Yes, Mr. McDermott.
    Mr. McDermott. Congresswoman Chu, our applicability of this 
would be across every organization that we do business with so 
I cannot say that any one particular business would be 
disproportionately affected just by the withholding. Obviously, 
other things that you have discussed about small businesses and 
the impact it may have on that.
    Ms. Chu. Mr. George, the SBA estimates that nearly 75 
percent of all small firms will fail within the first five 
years, while existing firms may be able to absorb a 3 percent 
withholding, newly formed firms are often the most cash 
strapped. At a time when we should be promoting economic 
development, has your office done any assessment on the impact 
that the 3 percent requirement would have on start-up 
companies?
    Mr. George. We have not done that, but one thing we have 
tried to do for small businesses, is we just implemented a new 
rule where we can accelerate payments to small businesses. So 
we are aware it is important to increase their cash flow, so we 
are trying to do that as a Department.
    Ms. Chu. Thank you. I yield back.
    Chairman Mulvaney. Thank you. I recognize the gentleman 
from Florida, Mr. West, for five minutes.
    Mr. West. Thank you, Mr. Chairman. My question is for you, 
Mr. George and Mr. McDermott.
    A couple of weeks ago I had a really good conversation with 
a dear friend of mine, Colonel Pete Newell, who is the head of 
the Rapid Equipping Force for the United States Army. Are you 
familiar with the Rapid Equipping Force mission?
    Mr. McDermott. I am not.
    Mr. George. Not personally.
    Mr. West. Okay. The Rapid Equipping Force for the United 
States Army, what they do is they go out into the combat 
theaters of operation and they give recommendations from the 
soldiers that are on the ground and then they come back here to 
look for small businesses that can provide these requirements 
to these emerging technologies that they do not have to go 
through an entire long-drawn-out procurement process. You know, 
my concern when I look at this, and I would like to get your 
estimate, do you think that this 3 percent withholding 
provision would incentivize a lot of small businesses to go 
into contracts that can enable us to provide, you know, rapid 
technologies to our soldiers that are on the combat theaters of 
operation right now?
    Mr. George. Incentivize or decentivize?
    Mr. West. Well, do you think that as it is right now this 
provision, will it incentivize people to go into, you know, 
contracts with the United States Army to provide these emerging 
technologies for our soldiers in the field?
    Mr. George. I would speculate it would not incentivize them 
at all.
    Mr. West. Thank you very much. I yield back.
    Chairman Mulvaney. Thank you. At this time I would like to 
recognize the gentleman from Oregon, Mr. Schrader, for five 
minutes.
    Mr. Schrader. Thank you, Mr. Chairman.
    Since you are resident government experts, I will ask a 
couple questions. And if you are unable to answer them I would 
understand.
    The bill as originally conceived talked about some 
exceptions. Do you all know the exceptions to the 3 percent 
withholding?
    Mr. George. Off the top of my head, no.
    Mr. Schrader. All right. Given the fact, and you alluded to 
it a moment ago in your testimony, Mr. George, that there have 
been some improvements and changes in how we are addressing 
some of the delinquencies that have occurred. Could you 
elaborate a little bit on some of the others that are out there 
that have occurred since this bill was put in play and how that 
has hopefully, possibly affected your ability to collect money 
you would otherwise not have been able to collect from 
contractors?
    Mr. George. Well, I would say there are two. One is on the 
contracting side and one is on the Comptroller side as we 
mentioned. One is, again, very significant. They have to 
register if they have $3,000 or more in delinquent taxes before 
they get a contract. The contracting officer has to look at 
that, and if it is actually affirmative, they have to 
investigate that and may even refer that to the Debarment 
Official if there is an affirmative response. On the 
Comptroller's side, Mr. McDermott mentioned about the offset 
program as well. So those two things I think have been, at the 
prime contract level, very successful.
    Mr. Schrader. Are you able to quantify how much improvement 
you have gotten and DOD, you know, how your collections have 
improved quantitatively as a result of those types of 
improvements?
    Mr. McDermott. Congressman Schrader, for fiscal year 2010, 
because of the Treasury Offset Program, we were able to collect 
on approximately 3,500 instances of debt. I do not have the 
dollar amount to be able to quantify that. But prior to the 
Treasury Offset program we were not sharing that type of 
information so that would have been information we would not 
have had to offset those payments.
    Mr. Schrader. So that is good news. Without having to 
burden small businesses you are making progress with some of 
the newer regulations. Is it not also true that the acquisition 
forms and processes would have to be changed at some cost to 
the federal government as a result of this law if it gets 
implemented?
    Mr. George. On the acquisition side we would have to make 
some changes to our systems and also on the Comptroller side. 
And we would have to implement regulations to make sure we 
collect the 3 percent withhold. That is correct.
    Mr. Schrader. So to reiterate a point that I think is being 
made here, we are only seeing the tip of the iceberg in terms 
of increased cost to government contractors and small 
businesses as a result of this 3 percent withholding?
    Mr. George. There is definitely an increased cost. That is 
correct.
    Mr. Schrader. I guess I will yield back, Mr. Chair. Thank 
you.
    Chairman Mulvaney. Thank you, Mr. Schrader.
    I recognize the gentle lady from North Carolina, Ms. 
Ellmers, for up to five minutes.
    Ms. Ellmers. Thank you so much, Mr. Chairman.
    My questions are going to be directed to each one of you. 
You know, the cost of doing business in this country is 
extravagant and we are losing jobs and we are not creating jobs 
because of it. Mr. Loftis, in your opinion, does this 3 percent 
withholding increase jobs or decrease jobs?
    Mr. Loftis. Decreases jobs most decidedly.
    Ms. Ellmers. Mr. McDermott?
    Mr. McDermott. That would be out of my area of expertise, 
Congresswoman Ellmers, to answer.
    Ms. Ellmers. Well, from a common sense standpoint, if the 
cost of doing business is increased for any small business 
company, contractor, does not that really equal the loss of 
jobs? That is one less job for every regulation. Every tax that 
you have to adhere to, that could possibly be a job that you 
are not creating. Would you not agree?
    Mr. McDermott. Congresswoman Ellmers, I cannot disagree 
with you but I would not be able to base that on our estimates 
or what we are doing to implement this law. But I cannot 
disagree with you.
    Ms. Ellmers. So let me ask you this then. From a small 
business perspective, contractor perspective, do you believe, 
do you agree that the cost will have to increase for consumers? 
That the cost of doing business will go up because of this 3 
percent increase?
    Mr. McDermott. Again, Congresswoman Ellmers, I cannot say 
for sure. I am sure there are a number of different ways that a 
business person would look at this to try and compensate for it 
to ensure that they have appropriate cash flow and to 
compensate for their profit margins.
    Ms. Ellmers. Do you believe the revenue that has been found 
or the tax advantage that you had mentioned that there were 
some tax revenues that were found because of this, do you think 
that that fully offsets the cost to our consumers?
    Mr. McDermott. I do not have the exact dollar amount of 
what we collected but I am quite positive that it would be less 
than what we are estimating it would cost to implement this.
    Ms. Ellmers. That it would be actually less? The money that 
is actually generated for the government in tax revenue is 
actually less than the cost to the business owner?
    Mr. McDermott. From the Treasury Offset program, yes.
    Ms. Ellmers. Okay. Mr. George, could you----
    Mr. George. Let me answer that from a personal perspective. 
I think when you mention it will increase costs, I think it 
will increase costs. At one time I was on the board of a small, 
not-for-profit small business. It was a school, on the Board of 
Directors, and cash flow was incredibly important. And this 
will affect their cash flow. And if you do not have cash, you 
cannot pay employees. And that actually happened to us a few 
times. So I understand the impact to small businesses.
    Ms. Ellmers. Yeah, you know, I mean, we are seeing this 
over and over again. I had the opportunity back home last week 
when we were in our district sitting down with small business 
owners, some of them contractors, and the cost of doing 
business is so high that they cannot create jobs. There are so 
many issues. Regulation taxation is what is harming all of our 
businesses and that is why we are not creating jobs in this 
country. You know, the private sector is where these jobs are 
created and until we deal with these issues, we are going to 
continue to see this. We can turn this around. It is just going 
to take a matter of all of us putting our heads together.
    Thank you. With that, Mr. Chairman, I yield back.
    Chairman Mulvaney. Thank you, Ms. Ellmers.
    I have one or two brief follow-up questions for Mr. Loftis. 
Mr. Loftis, you mentioned in your testimony that--I think you 
said you are already starting to try to implement this. Is that 
correct?
    Mr. Loftis. Well, we have to study it. You know, the 
deadlines keep being pushed back, so the CG's Office has spent 
a significant amount of time. The Department of Revenue, I 
mean, all of these offices, we study and then it gets put off. 
And then we study it and it gets put off. We have to devote 
valuable man-time to it. The computer resources devoted to it 
and the changes needed are going to be particularly expensive. 
We have just gone to a new statewide accounting program, which 
of course will have to be altered.
    Chairman Mulvaney. And is that replicated at the counties 
and the town levels as well?
    Mr. Loftis. Counties and towns will have a very difficult 
time. You know, I think the threshold that you could drop below 
that you do not have to mind this regulation is $100 million. 
But for counties that have hospitals or school districts, that 
is not very hard to get through at all. And they are just not 
equipped. Treasurers' offices in some of the counties may be 
two people.
    Chairman Mulvaney. You know, we talk oftentimes up here 
about the importance of making permanent changes as opposed to 
continually making temporary changes. In your mind is there a 
difference between a one or two year extension and just a 
complete removal of this requirement?
    Mr. Loftis. The complete removal would be great. The 
uncertainty breeds just that, uncertainty, and that costs us 
money.
    Chairman Mulvaney. And how many contracts approximately is 
the state of South Carolina going to be impacted in?
    Mr. Loftis. Well, it is funny you ask that because I tried 
to find that out. And we do not know because the contractor 
process is so old it has never been brought on computers like 
it should be. So this is one of the problems. So when we 
started investigating whether or not we will have to have 
arbitration contracts that were multi-year extend into this 
period, we just do not know.
    Chairman Mulvaney. Is there any reason to think it is going 
to be better in any of the other states?
    Mr. Loftis. I cannot imagine, no. We are relatively small. 
I would think it would be awful in a state like California or 
Texas or New York.
    Chairman Mulvaney. I cannot imagine the headaches they 
would have.
    Gentlemen, thank you very much. I really appreciate your 
time. Does anyone have any follow-up questions? Thank you 
again.
    At this time I would like to seat our third panel. The 
final panel is made up of three small business witnesses and a 
government contracts expert.
    The first witness is Mr. Mike Murphy, president of Murphy 
Turner Company, Inc., a third-generation, family-owned general 
contractor specializing in water and waste water treatment 
plants. He is also from Rock Hill, South Carolina. Mr. Murphy 
is testifying on behalf of the Associated General Contractors 
of America. I am especially pleased to welcome Mr. Murphy as he 
is one of my constituents.
    We also have with us Mr. Ian Frost, a principal at EEE 
Consulting in Mechanicsville, Virginia. He is testifying on 
behalf of the American Council of Engineering Companies. Mr. 
Frost, welcome as well.
    And we have Mr. James Gaffney, vice president of Goshen 
Mechanical in Malvern, Pennsylvania, testifying on behalf of 
Quality Construction Alliance.
    And we also have an additional witness who will be 
introduced by the ranking member, Ms. Chu.
    Ms. Chu. Thank you, Mr. Chair.
    It is my pleasure to introduce Kara Sacilotto, who is a 
partner with the law firm Wiley Rein Law Firm and is an expert 
in federal procurement law and policy. She has extensive 
experience in litigation matters relating to government 
contracts, including bid protests, claims litigation, prime 
subcontractor disputes, and trade secret misappropriation 
litigation. She regularly counsels government contractors 
regarding compliance matters and has conducted numerous 
internal investigations of alleged misconduct by government 
contractors. Ms. Sacilotto is also an adjunct faculty member at 
George Mason Law School. Thank you for being here today, Ms. 
Sacilotto.
    Chairman Mulvaney. Thank you, Ms. Chu. And welcome, Ms. 
Sacilotto as well.
    We will begin with Mr. Murphy. Mr. Murphy.

                    STATEMENT OF MIKE MURPHY

    Mr. Murphy. Thank you. Thank you, Chairman Mulvaney and 
Ranking Member Chu for the opportunity to testify on the 3 
percent withholding law. I am testifying on behalf of the 
Associated General Contractors of America, a national Trade 
Association representing more than 32,000 companies, including 
7,000 of America's leading general contractors and 11,000 
specialty contractors.
    My name is Mike Murphy. I am president of Turner Murphy 
Company. My dad, Turner Murphy, started our company in 1950. We 
are a third-generation construction company based in Rock Hill, 
South Carolina. Today we work primarily on wastewater and water 
treatment plants construction ranging in size from $100,000 to 
$25 million. We employ seven full-time employees in the office 
and 20 to 40 in the field depending on how much work we have. 
However, I believe Congress is making it tougher and tougher 
for my company to stay in business by not repealing a 
requirement that will make federal, state, and local 
governments withhold 3 percent from each and every payment to 
contractors for goods and services.
    This withholding applies to the total contract, not to the 
taxable net revenue generated from a project. This provision 
has nothing to do with my company's tax liability. It is just 
an accounting gimmick that whitewashes over the real costs of 
government while leaving small companies like mine holding the 
bag.
    This 3 percent holding is more than the profit margin on 
most public construction contracts for companies like mine. The 
average take-home after taxes for construction is 3.2 percent, 
and for smaller construction companies, 25 million and under, 
the margin is closer to 1.6 percent. So the 3 percent 
withholding is almost 200 percent of the total profit for small 
companies.
    Local, state, and federal governments already hold five to 
10 percent on our payments until project completion. Retainage 
is different than this withholding requirement in that it is 
tied directly to the project and is released when the project 
is completed. The 3 percent withholding is not tied to the 
project nor based on any project performance criteria. It is 
not released when the project is completed. It is held for as 
much as a year or more. It is just an interest-free loan to the 
federal government.
    This withholding also affects critical parts of my business 
such as cash flow and bonding capacity. When the public owner I 
am working for withholds 3 percent from each and every payment 
it causes my company to finance more of the work on the project 
without being paid for it. This ripples down to my suppliers, 
subcontractors, and service providers. Some suppliers ask for 
payment upfront, which means I am paying for things before even 
being reimbursed by the government entity. The additional 3 
percent withholding will make this process even worse, which 
could possibly hamper the ability of some general contractors 
to pay their subcontractors in a timely manner.
    This reduced cash flow would also restrict bonding capacity 
which is a key to my company being able to bid on projects. 
Federal law requires that construction contractors carry 
several types of bonds. Surety companies who provide the bonds 
study my books in detail before offering coverage. Based on 
past performance on contracts, the suitability of my company to 
perform the work for which I bid, my assets, and my cash flow, 
surety gives Turner Murphy Company a bond rating which governs 
the price of the bonds and how much bonded coverage I can 
receive. My ability to get bonding directly impacts how much 
work my company can take on.
    Implementation of this law could not come at a worse time 
for my company and my industry. The construction industry went 
into a recession a year and a half before the overall economy 
and still has not emerged from it. The industry has lost nearly 
a third of its workers and nearly a third of the construction 
put in place since 2006. The tough economic conditions have 
made competition on public jobs fierce and profit margins 
tight. We are seeing more and more bidders on a dwindling 
number of projects. This causes many companies to shave more 
and more out of profit margins in hope of actually getting the 
job.
    What is truly frustrating for us is that there are already 
policies in place that prevent the kind of tax behavior this 
law is designed to stop. Instead of punishing all contractors, 
the federal government should enforce the laws already on the 
books. Existing laws require all corporations to make quarterly 
estimated tax payments to cover income tax liabilities. These 
laws should be vigorously enforced, and on public projects all 
of our jobs are bonded. Having bonds on projects ensures the 
taxpayers that the jobs will be completed at no additional cost 
to the public.
    This new 3 percent withholding law is just another layer of 
red tape that creates serious cash flow problems for government 
contractors in perhaps the worst industry conditions in modern 
times. It does not help solve a problem by using solutions that 
are already on the books. It is just a bad public policy. Three 
percent withholding on government contracts will seriously 
impact my business and the businesses of the construction 
industry at large. The vast majority of the members of the 
contracting community are responsible taxpayers. Do not punish 
the whole industry because of a few bad apples.
    Again, thank you for the opportunity to testify on behalf 
of ADC, and I appreciate the fact that three members of the 
Subcommittee and six members of the Full Committee have co-
sponsored this legislation. I look forward to any questions 
that you may have that will help get the rest of you to co-
sponsor H.R. 674.
    [The statement of Mr. Murphy follows:]
    Chairman Mulvaney. Thank you, Mr. Murphy. I appreciate 
that.
    Mr. Frost, you are recognized for up to five minutes.

                     STATEMENT OF IAN FROST

    Mr. Frost. Chairman Mulvaney, Ranking Member Chu, and 
members of the Committee. I appreciate the opportunity to 
testify today on the three percent withholding mandate, and 
particularly its impact on small firms that contract with 
federal, state, and local entities of government.
    My name is Ian Frost and I am the president of EEE 
Consulting. We are a small engineering firm based in Richmond, 
Virginia. I am here to ask for your assistance in repealing the 
three percent withholding rule.
    As you know, in 2006, Congress included a provision in the 
Conference Report for the Tax Increase Prevention and 
Reconciliation Act that requires federal, state, and local 
governments that spend more than $100 million a year on goods 
and services to withhold three percent from payments to 
engineering firms and other contractors. I am also a member of 
the American Council of Engineering Companies, ACEC, the voice 
of America's engineering industry. ACEC firms number more than 
5,000, over 70 percent of which are small firms. Most have 
government clients, and like EEE Consulting, would be 
negatively affected by the three percent withholding mandate.
    EEE Consulting has been in business since 1998 and has 
grown to a 36-person firm with revenues of about $4.3 million 
last year. About 95 percent of our work is for local, state, 
and federal agencies. During one of the most difficult economic 
periods that we have lived through, we have experienced steady 
growth. Since the recession started, we have actually added 13 
new employees, five of whom were unemployed. We also signed an 
agreement to build a new office just as the recession hit. 
Despite a lot of trepidation over the economic forecast, we 
stayed the course on the new building and moved in during the 
spring of 2010. Our success could not have occurred without an 
unencumbered cash flow. We have relied upon the personal 
finances of our owners and the company's cash reserves to buy 
new equipment, to pay the salaries of new employees until we 
get paid by our clients, and to pay for expansion of the 
company, including the new construction.
    To a small business, cash flow is everything. I am 
immensely proud of our past record, yet concerned about the 
future because the pending three percent withholding rule would 
negatively affect our cash flow and our potential to grow and 
add new jobs. If enacted right now, the rule would mean the 
withholding of approximately $130,000 of our projected 2011 
revenue and it might require our company to secure a loan to 
help us cover operating expenses at a time when cash in the 
bank is limited. The withholding could limit our ability to 
make payroll each month, our ability to expand our business, 
and hire new employees. A $130,000 withholding each year would 
deplete our cash reserves by about 30 percent.
    Our situation is not unique. Our trade association, ACEC, 
has raised serious concerns over how this mandate will impact 
engineering firms, including thousands of small firms like mine 
that work for government. Many engineering companies realize a 
profit margin of just about three to five percent on a 
contract, and withholding three percent up front for tax 
purposes will force them to divert funds needed to complete the 
contract, thereby creating cash flow problems. Three percent 
withholding will also burden small firms with additional 
administrative and recordkeeping costs. Firms like mine will 
have to modify their accounting systems in order to keep track 
of the withholding and ensure that it matches with their tax 
records and tax refunds.
    I frequently hear in the news that small businesses are the 
economic engine for the country and are likely to be the main 
source of job creation that is needed to reduce our 
unemployment rate. Why then would the federal government want 
to handcuff that economic engine by withholding a percentage of 
our contracts, hurting our cash flow, and limiting our ability 
to add new jobs?
    I know that the withholding rule is intended to help with 
tax collections, but it seems unreasonable to punish everyone 
involved in government contracting due to the actions of just a 
few. The only solution to this problem is to repeal the three 
percent withholding mandate and replace it with measures that 
target firms and individuals that are not in compliance with 
the tax laws.
    I have attached to my testimony a list compiled by the 
Government Withholding Relief Coalition of tax compliance 
measures that have been enacted since the three percent 
withholding provision was passed in 2006. For example, in 2008, 
the Federal Acquisition Regulation was amended to require 
potential federal contractors to certify that they are in 
compliance with their federal tax obligations. This provision 
makes noncompliance with the tax code grounds for suspension 
and debarment from government contracting. Measures such as 
this focus on the problem instead of impacting firms that pay 
their taxes.
    As an owner of a small business, I ask you to help give us 
relief from the unfair withholding rule. Please find 
alternatives that ensure that the government receives its share 
of our revenue without damaging our ability to operate, add new 
jobs, and meet our payroll.
    Thank you for the opportunity to participate in today's 
hearing, and I would be happy to respond to any questions.
    [The statement of Mr. Frost follows:]
    Chairman Mulvaney Thank you, Mr. Frost. And as I mentioned, 
we will take questions for the whole panel after the testimony 
is finished.
    Mr. Gaffney, you are recognized for up to five minutes.

                 STATEMENT OF JAMES M. GAFFNEY

    Mr. Gaffney. Good morning, Chairman Mulvaney and members of 
the House Small Business Committee, Subcommittee on 
Contracting. On Contracting and Work Force. Thank you, Chairman 
Mulvaney, for holding this important hearing today and for 
inviting me and my association to participate.
    My name is Jim Gaffney, and I am the principal owner of a 
small business mechanical construction firm, Goshen Mechanical 
Contractors, located in Malvern, Pennsylvania. My firm operates 
in the public sector construction markets throughout the 
greater Philadelphia area, in the Delaware Valley, and 
throughout Southeastern Pennsylvania. Our firm performs many 
public sector construction projects in which I am prime and 
subcontractor, such as public school new construction and 
retrofits and other municipal facilities, both as a prime and 
as the sub, with a variety of public sector entities that will 
be covered by the 3 percent withholding tax unfunded mandate if 
it is not repealed before it takes effect January 1, 2013.
    I am here today representing the Mechanical Contractors 
Association of America. MCAA is a nationwide specialty 
construction employer trade association based in Rockville, 
Maryland. MCAA's member companies perform all types of 
mechanical, plumbing, heating and ventilation, new construction 
and maintenance, and service work for public project owners 
nationwide. The vast majority of MCAA members' companies are 
small businesses and many of them perform projects of the type 
that will be covered by the 3 percent withholding unfunded 
mandate.
    I am also president of the Mechanical Contractors 
Association of Eastern Pennsylvania, which is based on the 
Philadelphia area and which counts a majority of small business 
contractors among its 100 members. Many of those firms, too, 
perform projects for government entities that will be covered 
by the 3 percent withholding mandate. I am also privileged to 
represent four other of our sister associations in an ongoing 
legislative quality construction alliance. These groups are the 
Sheet Metal and Air Conditioning Contractors National 
Association, the International Council of Employees of 
Bricklayers and Allied Craft Workers, the Finishing Contractors 
Association, and the Association of Union Constructors. 
According to the Bureau of Labor statistic figures, specialty 
construction employers present the vast majority of industry 
employment and over 64 percent of the employment overall in the 
industry. The majority of the QCA association member companies, 
too, are small businesses and they, too, perform a great deal 
of public work projects with the governmental entities that 
will be covered by the 3 percent withholding mandate if it 
should go forward in 2013.
    I should add that many of the QCA groups also actively 
participate in a wider government withholding relief coalition, 
which also adamantly espouses rapid repeal of the 3 percent 
withholding provision in Section 511 of the Tax Reconciliation 
Act of 2005 and the QCA fully supports that coalition's written 
remarks filed on the record for this hearing.
    My business is the American dream. I started my business 25 
years ago in the basement of my mother and father's home. We 
worked in the field by day and we bid at night and on the 
weekends. The only real downtime that I had was on Sundays for 
mass and breakfast with my wife and four children. Today we 
have over 20 employees and have work on hand of over $8 
million.
    The tax, quite honestly, will put me out of business. Last 
week I bid a project in a school district in Lower Merion 
outside of Philadelphia where I took the job for four percent 
just to keep the cash flow rolling. I lost the job by 3 
percent. With retainage being held on these projects at 10 
percent plus 3 percent, small business will be replaced by 
large brokers that will end up causing the end-user more money. 
Not only will the overall costs go up, but trust me, the 
quality of work will go down. As a prime contractor, I will not 
be able to hold the 3 percent on my subs. As a subcontractor, 
the prime will incorporate some kind of language to exclude the 
3 percent from my invoices.
    I have been in business for over 25 years. I pay my taxes 
every year and on time. It is very easy to determine what my 
taxes are by the billing systems that are used on our projects. 
For each project I must submit a detailed breakdown for the 
project before it starts--labor, material, equipment, 
everything. Soup to nuts. Once it is approved, I bill 
percentages each month for that work that was performed. Each 
month a CM, project manager, or owner's representative requires 
a walk-through to visually confirm all the work that I have on 
my invoice has been completed.
    Once my financial statements are updated--and they are done 
every three to six months because the bonding company in this 
economy is on our backs every day--these projects are listed 
showing the percentages that are completed and our taxes are 
based on that information. And with the restrictions and the 
quality background checks that are done in the state of 
Pennsylvania on a lot of the local state's and school district 
work, they actually require me to submit my financial statement 
before the project is bid. They make me have my accountant 
notarize that financial statement and sign a letter of non-
collusion.
    I hear from many economists that in these challenging times 
most people do not get it on how bad the economy is until the 
bomb goes off. I see a lit fuse with this tax. Between the 
extra costs needed for my office staff to track the tax 
withholdings and the extra work needed from my accountant, I am 
looking at at least a 24 percent increase in my costs for 
recordings.
    Thank you for your time.
    [The statement of Mr. Gaffney follows:]
    Chairman Mulvaney. Thank you, Mr. Gaffney.
    Ms. Sacilotto, thank you for waiting. You are recognized 
for up to five minutes.

                 STATEMENT OF KARA M. SACILOTTO

    Ms. Sacilotto. Thank you, Chairman Mulvaney, Ranking Member 
Chu, and members of the Subcommittee for the invitation to 
participate in today's hearing.
    You have heard firsthand from others regarding the economic 
impact of the 3 percent withholding on businesses and the 
enormous administrative costs the law will impose on federal, 
state, and local governments. I share those concerns but my 
testimony today focuses on a different aspect of the problem, 
the disruptive and costly impact of the withholding requirement 
on the federal procurement system, impacts that will likely be 
experienced by state and local governments as well. My 
testimony today is mine alone and does not represent the views 
of my firm or any of its clients.
    Today I address three impacts and why I believe government 
has the tools available already to target delinquent taxpaying 
contractors, making implementation of an across-the-board 
withholding that bears no rational relationship to past or 
future tax liability unnecessary. First, the 3 percent 
withholding undercuts federal policies and programs intended to 
assist small businesses in contracting with the federal 
government. These policies and programs which I describe in my 
written testimony are designed to ease the cash flow burdens on 
small businesses, remove barriers to entry, and otherwise 
promote small business participation in federal contracting. 
The 3 percent withholding requirement, however, directly 
undermines these policies by destabilizing cash flows. It will 
disproportionately harm small businesses and likely deter the 
innovative small businesses government is trying to attract 
from entering the federal marketplace at all.
    Second, the 3 percent withholding will discourage 
commercial item contractors from selling their products to 
government. Congress has enacted laws to encourage vendors of 
commercial items to sell their products to government so that 
government can take advantage of innovative, commercially 
available products, as well as commercial pricing. Over the 
past decade, however, as the pendulum of regulation has swung 
back in favor of oversight, commercial item contractors have 
found themselves subject to more and more of the regulations 
that apply to their noncommercial counterparts but that have no 
equivalent in the commercial marketplace. The 3 percent 
withholding and the costs of complying with and administering 
it are yet another added cost of doing business with the 
government. Given a choice of customers, it is entirely 
reasonable to believe that vendors of commercial items will 
decline to incur this additional cost. Government will then 
face reduced competition for acquisitions of commercial items, 
diminished access to innovative commercial products, and more 
than likely increased costs because the costs of dealing with 
the government no longer reflect the costs of the commercial 
marketplace.
    Third, there will likely be increased disputes between 
contractors and the government. Determining whether a contract 
has been materially modified such that the withholding would 
apply to contracts entered into prior to December 31, 2012, or 
if as the IRS proposes the government can apply the withholding 
to payments under any contract after January 2014, regardless 
whether the underlying contract includes provisions that permit 
such a withholding, are just two areas where disputes will 
arise. Acquisition regulations provide that if government 
wishes to add a new requirement or clause to an existing 
contract or make some other change that increases the 
contractors' costs, the contractor is entitled to compensation 
for the cost of the change. Thus, in addition to disputes that 
will likely arise when parties attempt to true up the 
withholdings, disputes will arise whether the government is 
even entitled to include the withholding requirement in the 
first instance and the cost for doing so.
    There are likely many more negative impacts on the 
procurement system that will surface if this provision is 
allowed to take effect. If there is good news to this story it 
would be that there are existing enforcement tools that make 
imposing this costly and burdensome requirement unnecessary.
    You have heard today about the IRS Federal Levy program 
that targets tax debt. This current law now permits the IRS to 
levy or offset up to 100 percent of any specified payment due 
to a vendor of goods or services sold or leased to the federal 
government. You have also heard that current regulations 
require contracting officers to determine whether a contractor 
is responsible prior to the award of any federal contract. To 
assist with this responsibility determination, acquisition 
regulations were amended in 2008 to require contractors 
submitting proposals to certify whether they have tax debt over 
$3,000. Contractors also are now required to report in a 
database largely available to the public but fully available to 
contracting officers civil administrative or criminal findings 
of liability or penalties over $5,000. Acquisition regulations 
were further amended to permit the government to suspend or 
debar a contractor from contracting with the government 
entirely for being delinquent in federal taxes. In 2010, the 
White House instructed the IRS and OMB to review the 
certifications and report whether delinquent contractors were 
receiving contract awards.
    In closing, I do not wish to diminish the seriousness of a 
failure to pay taxes but note that the system has mechanisms in 
place that can target delinquent taxpayers without harming 
taxpaying contractors. Given these existing mechanisms, the 
perceived benefits of the 3 percent withholding are vastly 
outweighed by the burdens and costs the withholding will 
oppose.
    Thank you again for this opportunity to share my views, and 
I am happy to address any questions you may have.
    [The statement of Ms. Sacilotto follows:]
    Chairman Mulvaney. Thank you, Ms. Sacilotto.
    I have a few questions for the panel. First to Mr. Murphy. 
Mr. Murphy, one of the things we have heard regularly today is 
that one of the fears here is that contractors will simply add 
this additional 3 percent to their bids and as a result prices 
will go up for everybody, including the taxpayer. But I 
understand from your testimony--I think you mentioned it 
briefly--it is actually worse than that. In your industry you 
cannot do that. Is that right?
    Mr. Murphy. That is correct.
    Chairman Mulvaney. Tell me why that is.
    Mr. Murphy. Our margins are so tight now there is always 
somebody that is willing to take the job cheaper, as Mr. 
Gaffney said, for one percent. And normally that added cost you 
would pass on but in this industry and the market we are in now 
you just cannot do it. It is just something else we are going 
to have to absorb. Another brick we are going to have to put in 
our load.
    Chairman Mulvaney. You and Mr. Gaffney both mentioned the 
concept of retainage, which I am familiar with but I am not 
sure everybody else here is. When you--tell us a little bit 
about how that works, how retainage works generally.
    Mr. Murphy. Okay. We have a contract with an entity, let us 
say Rock Hill. Say $5 million. The first pay request we send in 
is, say, for $100,000. Well, they pay us $90,000 of that 
$100,000. They hold the other 10 percent until the project is 
complete and you have passed certain milestones. So over the 
course of that project it will go--whatever the progress 
payments are, by the end of the project they have got a half 
million dollars of your money.
    Chairman Mulvaney. But you can get that money upon 
completion?
    Mr. Murphy. Right. It is up to us. When we finish, the 
sooner we finish, the sooner we get the money. With this money, 
we are up to--we are leaving it up to our good friends here in 
Washington to decide when and how we are going to get it.
    Chairman Mulvaney. And that is what I think a lot of people 
do not understand about the proposals is that retainage, which 
everyone in the industry is familiar with, you get when the 
project is finished. This 3 percent withholding is different. 
You do not get this 3 percent withholding back until you pay 
your taxes for the year in which the project finished. So you 
could finish a project in January of 2012 and not actually get 
your money until April 15th of 2013. So it is not retainage, 
although I have heard a lot of people say this is similar to 
retainage. It is just another 3 percent retainage. And it is 
actually much worse than that.
    We have asked a couple of folks--I will ask Mr. Frost and 
Mr. Gaffney and Ms. Sacilotto as well because I think you 
mentioned the legalities of this--why is another short-term 
extension not a solution? And I put that to anyone who wants to 
speak to it.
    Mr. Gaffney. For me personally, the problem I have is we 
just cannot afford--if I am bidding a project that is going on 
for two years or three years and this could be implemented in 
the middle of the project, we are having to walk away from it. 
So I am not bidding the work today for any of the long-term 
projects just because of the fear that this could come into 
play in the backend of the project, in the last year of the 
project. We just cannot afford it. I just could not do that. So 
that is why it is impacting us today.
    Chairman Mulvaney. Ms. Sacilotto.
    Ms. Sacilotto. Sure. Well, contracts every day are being 
entered into and some of those contracts are long-term 
contracts. They are not going--they are not just for the next 
couple of years. They are for the next five, seven, 10 years. 
And there are no provisions in the Federal Acquisition 
Regulation now that implement this 3 percent withholding. Yet, 
there are plenty of provisions that require the government to 
pay its bills on time and pay them in full. So we have a lot of 
instability in the market right now as contractors are trying 
to figure out, well, how am I going to deal with this. And 
contracting officers do not really have the tools necessary. As 
we can see, people are still trying to figure out how to 
implement this. So as contracts are being entered into now 
there is a great deal of uncertainty. Having instability in any 
market is obviously not a positive thing.
    Mr. Frost. And let me add to that, if I may. You mentioned 
that if it was delayed would that be helpful. And of course 
there would be some advantage there but you heard the gentleman 
from the Department of Defense speak to the fact that they are 
already planning for that and incurring costs associated with 
that planning, as is industry. And so if we are incurring costs 
when the ultimate outcome is going to hopefully be repeal of 
that mandate, then why not repeal it now?
    Chairman Mulvaney. And I think Mr. Loftis said the same 
thing. The states are doing the same thing in anticipation of 
it.
    Mr. Frost. Exactly.
    Chairman Mulvaney. Mr. Murphy, you had an addition?
    Mr. Murphy. To me, putting it off another day does not help 
because it is still a bad policy. It is not going to be any 
better a year from now, or two years from now, or three years 
from now.
    Chairman Mulvaney. Mr. Murphy, you mentioned one thing--and 
this will be my final question--that caught my attention. You 
mentioned that the average margin to a contractor of your size, 
3.2 percent I think you mentioned. And then you mentioned that 
for a lot of the subs who are smaller than you it was down as 
low as 1.6 percent. And I think that drove home for me how 
dramatic the impact--while the impact of this bill would be 
felt industry-wide, the smaller the business the more dramatic 
it would be. How would your subs be able to operate under this 
system?
    Mr. Murphy. Like Mr. Gaffney said, some of these you would 
not be able to pass it on to them. They would just go out of 
business because a lot of these guys that we deal with, 
concrete finishers and some mason stuff, you have to pay them 
every week. You hold 3 percent for a year on them, they would 
just go out of business. Or they would quit doing work with 
you.
    Chairman Mulvaney. Thank you very much. I will recognize 
Ms. Chu for as much time as she would like.
    Ms. Chu. Thank you.
    I wanted to follow up on several of the issues you raised. 
Ms. Sacilotto. Ms. Sacilotto, one of the central themes of your 
testimony was that the 3 percent withholding rule undermines 
other government initiatives established to promote economic 
growth for small firms. Can you explain how those traditionally 
disadvantaged firms, such as minority-owned or women-owned 
firms would be impacted?
    Ms. Sacilotto. Sure. I can give you--well, if a company 
cannot raise money to operate its business, obviously any 
policy that we put into effect, just at a broad level, is not 
going to be effective because it will be driven from the 
market. But a specific policy that is put into effect in the 
Federal Acquisition Regulation and even more so by DOD is to 
give small businesses a greater percentage of their progress 
payments. So a traditional large business, the default is 80 
percent of your costs. Small businesses, depending on whether 
it is with a civilian agency or DOD, can get up to 95 percent 
of their progress payments. And there is also, you heard 
mentioned, a DOD policy that was recently enacted to accelerate 
payments to small businesses. Well, shaving off 3 percent is 
obviously directly undermining those policies that are meant to 
assist small business with contracting with the government. It 
undermines--the notion that you will get paid faster yet you 
will get paid less is not exactly equal.
    Ms. Chu. You also raised the issue pertaining to Federal 
Acquisition Regulation--complex federal contracting regulations 
already serve as a huge barrier to small firms seeking 
government work. Can you elaborate on how federal acquisition 
regulations would be modified if the 3 percent withholding 
became effective and what this would mean for small businesses 
in the contracting arena?
    Ms. Sacilotto. Honestly, I think that the repercussions are 
going to be enormous. And I have not studied this but I have 
been thinking about recently the Prompt Payment Act. The Prompt 
Payment Act is a government law that was enacted because the 
federal government did not have rules about when it paid its 
invoices. So sometimes it was paying too late and incurring 
interest, and sometimes it was paying too early and losing the 
time value of its money. So the Prompt Payment Act has rules 
about when you pay your invoices. And if you do not pay your 
invoices on time, the contractor is entitled to interest. If 
the government pays early, there are certain clauses that are 
in the FAR, which is the Federal Acquisition Regulation, that 
allow the government to get a discount for paying early.
    It seems to me that the entire prompt payment system is 
going to be--is completely broken. If the government can 
essentially not pay promptly 3 percent of the payments that are 
owed, are they going to incur interest on that because they are 
not paying it promptly? And the idea of this was the government 
was realizing it was losing a vast amount of money--the time 
value of money by paying too early. Well, contractors are now 
losing that time value of money by paying their taxes early. So 
should the government get a discount for paying early when it 
is withholding 3 percent of the money? This is just one tiny 
little aspect of the contract process that I think will be 
affected by this 3 percent withholding. This applies to small 
businesses, large businesses, all businesses. And contracting 
officers and our acquisition workforce who are stretched thin 
already are going to have to try to figure out how to deal with 
this.
    Ms. Chu. And my final question has to do with those 
commercial item vendors, those small businesses that offer all 
kinds of items, including high tech products that would be 
available on the commercial market. In your testimony you 
mentioned that 3 percent withholding would disproportionately 
dissuade commercial item contractors. What is unique about this 
industry that would create this situation?
    Ms. Sacilotto. Well, when you think about a commercial item 
contractor you are thinking about somebody who--a company 
that's business is not tailored to, you know, perhaps building 
a bomb or something that is specific to the federal government. 
It is providing perhaps IT services and cloud computing and 
things that I do not even know about because they are so high 
tech and innovative. Well, they can sell their products out on 
the free market to companies, to businesses, to anybody. They 
do not have to necessarily--they are not beholden to the 
federal government for this. It is a great market to enter into 
but is it such a great market to enter into when I have this 3 
percent withholding and every other cost of doing business? As 
a small innovative business, if I have options, this will 
definitely make me consider whether or not it is worth it to 
come into the federal marketplace.
    Ms. Chu. Thank you. I yield back.
    Chairman Mulvaney. I recognize the gentle lady from North 
Carolina, Ms. Ellmers, for up to five minutes.
    Ms. Ellmers. Thank you, Mr. Chairman.
    Ms. Sacilotto, my question for you is you had outlined that 
there are already provisions in place that should be dealing 
with these issues as far as, you know, the revenue coming in, 
the tax burden, that we may be lost. Is that correct that you 
feel they are already in place?
    Ms. Sacilotto. Yes.
    Ms. Ellmers. And yet they are not being adhered to?
    Ms. Sacilotto. Well, that I do not know from an IRS 
perspective whether or not they are being adhered to. I believe 
that a number of laws have been passed recently to allow the 
IRS to withhold more and more money. I would say that the 
recent GAO report that came out that the chairman mentioned, 
there were 15 cases of delinquent taxpayers that were, I guess, 
emphasized in that report. The IRS has gone after all 15 of 
them so I cannot say that it is not working.
    Ms. Ellmers. Well, based on the information that we have 
and considering that there are things that are already in 
place, why do you, you know, it seems to me the impetus for 
this is to find this money, this 3 percent withholding in order 
to help pay for that or to find that or to locate those monies 
that might not be coming in and, you know, pretty much put that 
burden on all of our good taxpaying citizens because of those 
few that do not. If, in fact, those things that are already in 
place really do not seem to be working, why would this work? In 
your opinion, what would make this the golden egg of finding 
tax revenue?
    Ms. Sacilotto. Well, I do not think this is the golden egg 
of finding tax revenue. And like I said, I cannot say that 
those measures are not working. Some of the evidence suggests 
that they really are. And to go back to this GAO report, I 
would say that this--that report--it is unfortunate that there 
are contractors who do not pay their taxes. Nobody is going to 
defend that. But if you read the report, it was only five 
percent of the contracts that were actually examined.
    Forty-five percent of the taxes at issue that they found 
owing were excise--I am sorry, payroll taxes. They were non-
income taxes. So will this help that? No. It will not get that 
entire 45 percent of the problem that was identified. Also, 
half of the delinquent taxpayers were subrecipients and I think 
in my mind I think of a subrecipient as a subcontractor. Well, 
subcontractors are not subject to the withholding. It applies 
to the prime contractor.
    Ms. Ellmers. To the prime contractor.
    Ms. Sacilotto. Right. So that is under the IRS rule. So you 
are not getting all of those people. So, right there that is 
not getting all of the problems. There was an addition. Oh, and 
then the fact that the IRS is actually--it is taking 
enforcement actions against all 15 of the cases that it said 
were known really bad actors. Well, that to me suggests that 
the system is not broken. That we need to just focus on using 
the tools that we have available already rather than adding an 
additional tool.
    Ms. Ellmers. Thank you.
    Mr. Gaffney, if I am not mistaken I believe you had said 
that if this were to be put in place today it would cost you 
about 24 percent more to do business.
    Mr. Gaffney. Correct.
    Ms. Ellmers. And you would literally have to close your 
doors. Is that correct?
    Mr. Gaffney. When I say that I know it sounds like it is 
dramatic.
    Ms. Ellmers. No, no. It is not.
    Mr. Gaffney. It is the truth. In our business, you know, my 
mother is in the office, my sisters are in the office. When the 
girls are doing the accounting everyday downstairs we would 
actually have to come down, track down all our vendors which on 
a given project could be in the hundreds, make sure that the 3 
percent is held from the vendor, from the subcontractor, from 
another material supplier, and so forth and so on. And 24 
percent is probably a low number but I wanted to be 
conservative. And it will put us out for the reason that there 
is no money to the developers today. So in the Philadelphia 
area and the surrounding areas in Pennsylvania, there is no 
money for the developers. There is no cash flow out there. So a 
lot of the smaller businesses tend to go into the work that is 
either government at the state, local, whatever the case may 
be. With this 3 percent that goes in there, we just cannot do 
it. We cannot do it.
    For the most part, right now small businesses in my area 
are taking jobs for just about nothing, just to keep the money 
coming in so the bonding company is happy and the banks are 
happy for the line of credit. If it was not for that, we would 
be gone. With that 3 percent being held for whatever the period 
of time is, it is coming. It is just a matter of time.
    Ms. Ellmers. Thank you. Mr. Chairman, can I have one more 
minute for--I would like to ask Mr. Frost and Mr. Murphy----
    Chairman Mulvaney. With no objection you are recognized for 
an additional minute.
    Ms. Ellmers. Okay. Mr. Frost and Mr. Murphy, I just wanted 
to ask both of you, you know, as business owners, I believe, 
Mr. Murphy, you had said that basically this would--for your 
projected income of 2011 or your projected project it would 
cost you about $100,000. Is that----
    Mr. Murphy. Well----
    Ms. Ellmers. I am sorry, Mr. Frost, you had said----
    Mr. Frost. We would lose about $130,000 of revenue if it 
was in today's dollars.
    Ms. Ellmers. Simply just to adhere to this?
    Mr. Frost. Yes.
    Ms. Ellmers. In your opinion, how many jobs would--if you 
know that that is a cost that you are not going to have to 
incur, can you create--would you be able to go out today and 
hire someone else to work under you?
    Mr. Frost. It would be extremely difficult. As I said, our 
history has been that we have been hiring people and we have 
been able to do that because our cash flow has allowed us to. 
We would have to take loans if we were going to hire additional 
people to cover their payroll until we got paid by the federal 
government or the federal, state, and local governments.
    Ms. Ellmers. Sure. And Mr. Murphy, if you could answer that 
as well.
    Mr. Murphy. I agree with Mr. Frost and I will make one 
comment about cash flow. A guy told me this a long time ago. It 
is not air but it is pretty close to it. So it is that 
important.
    Ms. Ellmers. Well, absolutely. And you know, again, and in 
your opinion for both of you, you know, if we just--if we just 
put this off for a few months or a year you are still going to 
be in the same situation because you are still going to be 
faced with that uncertainty. Correct?
    Mr. Murphy. The uncertainty of it and the inevitability of 
it if it happens. I mean, it is not like it is going to be 
easier to take a year from now.
    Ms. Ellmers. Right. Thank you so much for your testimony. I 
really--it has been invaluable to this situation. Thank you.
    Mr. Murphy. Thank you.
    Chairman Mulvaney. Thank you, Ms. Ellmers. And that 
provides a good closing for the whole meeting. Thank you for 
everybody who came. Thanks especially to the folks who came 
from out-of-town. I appreciate you incurring the time and the 
expense to do that. I do not think that folks who come to 
testify often recognize how important these hearings are and 
how valuable they can be to shed light on issues that 
ordinarily would not see the light of day. This is not an issue 
that makes the front page of the Wall Street Journal or the New 
York Times, but this is an absolutely critical issue for your 
economy, for our small businesses, and as you can tell, for 
state and local government, the Department of Defense. This is 
an important issue and the fact that you were able to come 
today, give us your testimony in writing, have a chance to give 
us your oral testimony and then take questions is 
extraordinarily helpful to us as we try and push this bill 
through on what appears is going to be to all aspects a 
bipartisan basis. So I really appreciate--the anecdotes 
especially help us explain to our colleagues exactly how 
important this is, how powerful a change this would be if we do 
not fix it, so I appreciate everyone's time.
    With that I would ask unanimous consent that we have five 
legislative days to submit statements and supporting materials 
for the record. And without objection, thank you all to 
everybody who came. And that will conclude this meeting.
    [Whereupon, at 11:35 a.m., the subcommittee was adjourned.]


                      CERTIFICATE OF NOTARY PUBLIC


                          DISTRICT OF COLUMBIA

    I, Christine Allen, notary public in and for the District 
of Columbia, do hereby certify that the foregoing PROCEEDING 
was duly recorded and thereafter reduced to print under my 
direction; that the witnesses were sworn to tell the truth 
under penalty of perjury; that said transcript is a true record 
of the testimony given by witnesses; that I am neither counsel 
for, related to, nor employed by any of the parties to the 
action in which this proceeding was called; and, furthermore, 
that I am not a relative or employee of any attorney or counsel 
employed by the parties hereto, nor financially or otherwise 
interested in the outcome of this action.

    ____________________
    Notary Public, in and for the District of Columbia
    My Commission Expires: January 14, 2013

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