In 2008 a lucky engineering firm snagged the top spot on a list of leading small business contractors to the federal government. Based in Alexandria, Va., the company had signed an impressive 39 contracts with government entities ranging from the U.S. Navy to the Department of Energy. The catch? The "small business" in question, VSE Corp. (VSEC), employs 1,920 workers and posted $1 billion in revenues last year.

VSE's incongruous distinction illustrates a persistent problem in the federal contracting system: the mislabeling of corporate titans as small businesses. Federal guidelines mandate that 23% of all government contracts be awarded to small businesses, which generate roughly half of private-sector employment and more than half of private, nonfarm GDP.

But at least 16 companies with more than $1 billion in annual revenues were among the top 100 small business contractors in 2008, according to Eagle Eye, a Virginia research firm that tracks federal spending. In addition to VSE, giant defense contractors Lockheed Martin (LMT, Fortune 500) and General Dynamics (GD, Fortune 500) each earned more than $120 million in small business contract payments last year.

On May 21, Rep. Hank Johnson, D-Ga., moved to remedy this situation by introducing the Fairness and Transparency in Contracting Act, which prohibits publicly traded and foreign-owned companies (or their subsidiaries) from being classified as U.S. small businesses for government contracting purposes. The bill also requires that small business contract holders have their names reported quickly and that they be listed by the name of their parent companies so that large firms can't hide behind small subsidiaries.

"For far too long, large corporations have benefited when they should not have," Johnson says.

Small business advocates give the bill mixed grades. "Tightening the definition of small business would create significant opportunities for actual small businesses," says Brad Close, vice president of public policy at the National Federation of Independent Business, an advocacy group based in Washington, D.C.

Others argue that excluding public companies could make it harder for growing businesses to snag their fair share of federal contracts.

"Contracting is being bifurcated into two communities, a number of very large businesses and a number of protected small businesses," says Giovanni Coratolo, vice president of small business policy at the U.S. Chamber of Commerce. "I can't digest that you don't let public companies be counted as small. Why? You don't advocate for small business and put a ceiling on their ability to grow."

Large firms often end up on small business contractor lists because they buy small firms that have scored federal procurement contracts. Case in point: In September 2006 the Department of Homeland Security announced that 28 small businesses had been awarded portions of a large computer contract called Eagle. Since then at least 11 of these firms have been acquired. One, Alpha-Insight of Falls Church, Va., was bought by information technology giant CACI International (CACI) six months before its government contract win was announced.

In the end, small businesses would be helped most by the speedy removal of large businesses from the small business contract statistics, which would push government agencies to find true small businesses in order to reach their 23% goal. "More than likely, having correct data would drop the numbers," says Robert Burton, a former senior official at the Office of Federal Procurement Policy. "And there's no question that the government would come under intense scrutiny to meet its target."

Meanwhile, some tenacious small companies have managed to buck the system. In 2004 Federal Edge, a small computer reseller based in Riverside, Calif., lost out to technology behemoth GTSI (GTSI) for a $600,000 small business contract to provide computer equipment to the Air Force. GTSI grossed $1.1 billion in 2004 but had been incorrectly classified as a small business, says Federal Edge vice president Rod Stolk. Federal Edge filed a protest with the Air Force, won the contract and attracted media coverage from the Wall Street Journal, CBS News and this magazine.

"We were barraged with e-mails, phone calls and letters from small business owners across the country saying, 'Us too! Us too! Keep it up!'" Stolk recalls. "It's a tough gig for small businesses out there."