There is actually already a lot of law and regulation that deals with what types of functions contractors working for government are allowed to do.
IMHO the government far overstepped those lines during Bush and have failed to come back under Obama, as that would mean taking on civil servant headcount to replace the contractors leaving, which is politically a hot potato.
Unfortunately the people only rarely expect and demand less service from the government; instead they want the government to stop all the stuff that they don't personally use. So of course this means that the government rarely stops with a given function entirely.
The military ended up with the same problem. The draft would not be politically feasible and you only get to go to war with "the Army you've got, not the Army you'd wished you had". What the Army did have was money, and so they farmed out everything they could make even a half-hearted case as being a "generic business function" (e.g. building security) off on private contractors.
And that's even with the Navy drawing down on its already-undermanned force to send sailors to Iraq and Afghanistan to free up even more soldiers to do Army-type things.