U.S. Defense Contracts During the Tax Expenditure Battles of the 1980s

Abstract

This paper considers the impact of the tax treatment of military contractors on the cost and timing of U.S. military procurement. Prior to the early 1980s, taxpayers were permitted to defer tax obligations on profi ts earned from long-term contracts. Legislation passed in 1982, 1986, and 1987 required that at least 70 percent of the profi ts earned on long-term contracts be taxed as accrued, thereby signifi cantly reducing the tax benefi ts associated with long term contracting. Comparing contracts that were ineligible for these tax benefi ts with those that were eligible, it appears that between 1981–1989 the duration of U.S. Department of Defense contracts shortened by an average of between one and two months, or somewhere between 10 and 23 percent of average contract length. This pattern implies that the tax benefi ts associated with long term contracts promoted artifi cial contract lengthening in the 1980s, and suggests that the Department of Defense ignores the federal income tax consequences of its procurement actions, thereby indirectly rewarding contractors who benefi t from tax expenditures.