Legislation to repeal a rule that would withhold 3% of government payments to contractors is gaining steam, passing the House with strong bipartisan support and the Obama Administration’s sign-off.

“The House of Representatives proved that members on both sides of the aisle can come together to improve our economy,” said Bruce Josten, Chamber executive vice president for Government Affairs. “The bipartisan repeal of the 3% withholding tax is an important step to removing one of the onerous government burdens on job creators that have hampered our economic recovery. With the Administration’s support, and the strong bipartisan vote in the House, it is our hope that the U.S. Senate will take up this legislation, put politics aside, and pass the 3% repeal once and for all.”

Section 511 of the Tax Increase Prevention and Reconciliation Act of 2005 requires that federal, state, and many local governments withhold 3% of payments for goods and services as a way to close the gap between taxes owed and taxes collected. It also applies to Medicare payments and farm payments. Implementation of the rule has been delayed repeatedly and currently is scheduled to take effect on January 1, 2013.

Withholding would be a big burden to business owners like Terry Neimeyer, CEO of KCI Technologies Inc., a government contractor. Neimeyer’s 850 employees in 20 offices in 15 states provide engineering services to state and local agencies. Seventy percent of KCI’s work is for public sector clients. “Our top 10 clients all have department of transportation after their names,” he told Free Enterprise magazine during an interview.

Neimeyer argues that the 3% withholding provision will significantly reduce his company’s cash flow. “We have over $100 million in work for these DOTs, which means we’d be handing over a $3 million interest-free loan to the government every year for all intents and purposes.” That’s money Neimeyer says he could use for materials, supplies, and 100 new engineers.

Full repeal legislation has been held hostage by the debate over how to offset the $11 billion in foregone revenue to the Treasury over the next decade. The House-passed bill changes the way last year’s new health care law determines who is eligible for Medicaid and health exchange subsidies. The shift is expected to save $13 billion.

On October 25, the Obama Administration signaled that it supported both the full repeal and the change to the health insurance subsidies. The White House said in a statement that the bill “would reduce a burden on government contractors who otherwise comply with their tax obligations, particularly small businesses. ... The effect of the repeal of the withholding requirement would be to avoid a decrease in cash flow to these contractors, which would allow them to retain these funds and use them to create jobs and pay suppliers.”

The debate now moves to the Senate, where success is less clear. Senate Democrats prefer paying for the repeal by eliminating corporate loopholes for corporate jet owners and other measures aimed at higher earners.

The Associated General Contractors of America recently released a survey of 1,300 construction firms showing that 63% of firms reported that their average profit margin for public projects is less than 3%. Forty-nine percent of firms said the withholding measure could force them to decrease their hiring plans, and 67% said the measure would force them to raise their bid levels.