Military

  Men and women in our military are putting their lives on the line every day for our nation.  At the same time, GAO tells us that over 27,000 of DOD's contractors - more than 1 in 10 - are dodging their tax bills and have outstanding tax debts to Uncle Sam totaling at least $3 billion.  27,000 DOD contractors with $3 billion in unpaid taxes.  I'm not sure which figure is more shocking.

 Tax dodging by any federal contractor is unfair - not only to the honest taxpayers left to make up the difference, but also to the honest companies that have to compete against the tax dodgers for government contracts.  Tax dodging by contractors taking taxpayer dollars to support our military is not only unfair, it is unpatriotic and unacceptable.

 GAO tells us the vast majority of the 27,000 DOD contractors with unpaid taxes, more than 25,600 of them, have failed primarily to pay payroll taxes.  That means these contractors have failed to send to the IRS sums withheld from employees' wages for federal, state, Social Security, and Medicare taxes.  When GAO took a closer look at 47 of these DOD contractors, GAO found that all 47 had evidence of tax avoidance and, in some cases, unearthed unseemly tales of individuals and companies dodging taxes for years and using the money meant for payroll taxes on luxuries for themselves instead - expensive homes, cars, boats, and vacations.  One contractor with $10 million in unpaid taxes had been paid $3.5 million in taxpayer dollars in FY2002 alone to provide custodial services at military bases.  This contractor had already defaulted on an IRS installment agreement, yet it is unclear whether a dime of the $3.5 million was withheld to pay down the contractor's tax debt.

 Tax chiseling by federal contractors isn't a new story.  It's an old one.  And it's one that Congress has tackled in the past to recoup unpaid taxes and prevent new tax abuses.  In 1997, Congress enacted the Taxpayer Relief Act which, in part, authorized federal agencies to withhold 15 percent of any federal payment going to a person with an outstanding tax debt.  The goal was to stop taxpayer dollars from being paid to a tax deadbeat, unless 15 percent was withheld off the top to reduce that person's tax debt.

 The Taxpayer Relief Act sought to apply a common sense principle to government operations:  to offset the taxpayer dollars sent to people who haven't paid their tax bills by directing a small percentage of the total to reduce their tax debt.  But this common sense principle isn't easy to apply in a government that pays hundreds of thousands of contractors to work on even more contracts.  In essence, it requires the federal government to set up financial payment systems that make sure the left hand knows what the right hand is doing - to make sure, for example, that contract payments don't go to a contractor with an outstanding tax debt unless a portion is first withheld to satisfy a part of that debt.

 The first agency to tackle the problem was the Financial Management Service or FMS in the Treasury Department.  That agency took until July 2000 to establish an automated tax levy program under a larger Treasury Offset Program, which handles offsets for a variety of reasons.  Since then, FMS has sent about $76 million in tax levy money to the IRS, with about $60 million in FY2002 alone.

 It took another two years - until December 2002 - for DOD to follow suit.  Working with FMS, DOD set up its first automated tax levy program for its largest contractor payment system, called MOCAS, which handles payments on DOD's major, long-term contracts.  In FY2002, MOCAS payments totaled about $95 billion, all of which is now reviewed for tax levies before the money goes out the door.  DOD is planning to but has not yet extended its automated tax levy program to 15 other payment systems which, together, make contract payments totaling another $85 billion each year. 

 As currently operated, the DOD tax levy program is a joint effort involving DOD, FMS and the IRS.  It is a joint effort because, while FMS is authorized by law to review IRS data on unpaid taxes, DOD is not.  So here's what happens.  Each Monday morning, the Defense Financial and Accounting Service at DOD sends FMS an electronic file listing payments expected to be made to DOD contractors over the next few days.  FMS immediately uses a computer match program to compare the names and taxpayer information numbers in the DOD payment data with data in IRS files listing persons with unpaid taxes.  FMS compiles a list of the names that match and sends it to the IRS.  The IRS then makes sure it has mailed a 30-day notice of intent to levy to each of the listed tax delinquent contractors.  If the contractor does not respond within 30 days by paying up, protesting the tax debt, or offering to settle it, the IRS notifies FMS which, in turn, tells DOD to begin withholding the 15 percent from payments to the identified contractors.  DOD does so and forwards any levied funds to FMS which, in turn forwards the fund to the IRS.

 GAO estimates that, in light of the huge DOD contract dollars and tax dollars at stake, DOD's tax levy program ought to be collecting at least $100 million each year.  But last year, the first year of the DOD tax levy program, DOD collected less than $1 million, or less than 1 percent of the projected total.

 The GAO report spells out a number of reasons why.  The good news is that many, if not all, of these problems can be fixed.

 First, there is DOD.  Right now, DOD is sending FMS payment data on only one day per week for only one of its payment systems.  It needs to send more frequent payment data from all 16 payment systems.  Another problem is that the payment data DOD sends to FMS is currently tainted with thousands of incorrect or missing taxpayer identification numbers, which makes it nearly impossible to match many DOD contractors to IRS lists of tax delinquents.  DOD needs to set up new procedures to get valid taxpayer identification numbers (TINs) from its contractors and stop sending payments to contractors with invalid or missing TINs.  Finally, when faced with having to make a payment to a contractor without a valid TIN, DOD has never set up the system required by law to withhold 28% of each payment to that contractor until a valid TIN is supplied.  DOD needs to set up that backup withholding system.

 Next is the IRS.  One key problem here is that the IRS has caused DOD to miss imposing tax levies on numerous contract payments, because the IRS hadn't yet mailed the 30-day notice to the relevant contractors warning of an upcoming levy.  The IRS needs to revamp its levy notice procedures to eliminate delays and missed levies.  The IRS also needs to change tax collection policies that currently prevent DOD from using its tax levy program on many of its contractors.  For example, the IRS needs to end its practice of waiting a year before approving use of the levy program for contractors waiting in an IRS queue for assignment to a revenue officer.  I understand that the IRS is willing and may have already made this change.  Another problem is the IRS' automatic bar on using tax levies on contractors who are negotiating to settle, reduce, or stretch out repayment of their tax debt or are in bankruptcy or experiencing financial hardship, especially in the  case of contractors with defaults on prior repayment agreements or a history of nonpayment of tax.

 In essence, when it comes to contractors paid with federal taxpayer dollars, the IRS must become much less cautious in using the 15 percent tax levy authorized by law, and it must stop allowing tax delinquent DOD contractors to receive full payment in taxpayer dollars without having a dime directed toward the taxes they've  dodged.  The IRS also needs, for the first time, to assign full-time revenue officers to the tax levy programs aimed at federal contractors, so that these officers can develop expertise, improve the DOD and FMS programs, and cut down on the tax abuses committed by federal contractors.
 
 Senator Coleman and I have been working on developing recommendations to strengthen the DOD tax levy program based upon the GAO report and discussions our staffs have held with the three agencies.  DOD and the IRS have already indicated their willingness to make reforms, have made some concrete changes, and are considering additional improvements as well.  Here are some of my thoughts about key improvements to strengthen use of tax levies for federal contractors.

 Recommendations for DOD

 (1) 16 Payment Systems.  DOD should meet its March 2005 deadline for automating tax levies in all 16 of its payment systems, thereby bringing $85 billion more payments under review each year in DOD's tax levy program.

 (2) More Frequent Payment Data.  DOD should send its contractor payment data to the Financial Management Service more than once week and as often as practical to increase IRS matches and identify more tax delinquent contractors.

 (3) TIN Consent.  DOD should require all registrants in the federal Central Contractor Registration (CCR) database to provide consent during the registration process for DOD to obtain IRS information to validate their taxpayer identification numbers (TINs), and DOD should work with the IRS to validate all TINs in the CCR.

 (4) TIN Requirement.  DOD should prevent contract payments to any contractor with an invalid or non-existent taxpayer identification number.

 (5) Backup Withholding.  In FY 2004, DOD should establish systems to require automatic backup withholding from payments to any contractor with an invalid TIN, as required by law, and notify CCR registrants that contract  payments are subject to such withholding.

 Recommendations for IRS
 
 (1) Using Tax Levies Sooner, Not Later.  The IRS should change its tax levy policies to use levies as a first resort, rather than a last resort, for tax delinquent federal contractors.

 (2) Dedicated Revenue Officers.  The IRS should assign full-time revenue officers to specialize in collecting unpaid taxes from levies on federal contractors, and work with DOD and FMS to improve the efficiency and effectiveness of their tax levy programs.

 (3) Levy Notices.  The IRS should revamp its procedures for issuing levy notices to federal contractors to eliminate delays, and consider such options as combining levy notices with delinquency notices and sending levy notices to tax delinquent CCR registrants with active contracts.

 (4) Queue Reform.  The IRS should eliminate the policy automatically barring initiation of a tax levy for one year on any federal contractor waiting in the IRS queue for assignment to a revenue officer, and instead initiate tax levies on federal contract payments as a routine matter.

 (5) Recidivist Tax Abusers.  The IRS should work with Congress to eliminate administrative and statutory barriers to initiating a tax levy on a federal contractor in negotiation to repay a tax debt, in bankruptcy, or undergoing financial hardship, if the contractor has defaulted on a prior IRS repayment agreement or has a history of repeated misconduct involving nonpayment of tax.

 Recommendation for OMB

 Study.  OMB, working with DOD, FMS, IRS and others, should conduct a study on whether federal contractors with unpaid taxes should be barred under some or all circumstances from bidding on federal contracts, and whether federal contracting officers should be informed of contractors who have engaged in longstanding or egregious tax avoidance so they can assist in tax collection efforts.

 DOD contracts represent nearly two-thirds of all federal contracts and, in FY2002, DOD contract payments totaled about $180 billion.  The recipients of DOD contracts, whether individuals or businesses, are given an unique opportunity to support the men and women in our military.  Most DOD contractors provide valuable goods or services to DOD, and do so while paying their taxes.  Other DOD contractors, however, take payment in taxpayer dollars, while dodging paying their taxes to Uncle Sam.  This tax dodging hurts honest taxpayers, honest businesses, and our country as a whole.  Effective use of the DOD tax levy program is necessary to help keep the tax dodger's hand out of the taxpayer's wallet.

 I commend Senator Coleman and Congresswoman Janice Schakowsky for their leadership on this important issue.  I look forward to the testimony today.