Part Three: Are There Any Alternatives?
Some politicians would like to repeal the 1997 income tax cut. Others suggest higher taxes on alcohol or other “sin” products. The Republicans would like to avoid new taxes by dramatically cutting education spending. Senator Rich Madaleno reports that as many as 80 bills may be filed by legislators for the special session, many of them related to the budget problem. Here’s my idea.
Your correspondent is a researcher for the United Brotherhood of Carpenters. One of the issues we encounter on many construction job sites is worker misclassification as independent contractors. Under state and federal tax laws, workers are supposed to be classified as employees when they operate under an employer’s direction (such as under established hours of work), use tools and equipment owned by the employer and do not bear business risk. Employers are required to withhold income, Social Security and Medicare taxes and pay premiums for workers compensation and unemployment insurance for their employees. However, many employers misclassify workers as independent contractors and pay none of the above. Workers may (or may not) receive Form 1099 to report income as independent contractors, but these forms are often discarded. This problem is especially severe in construction but also afflicts trucking, janitorial services and other industries.
Employers have a huge incentive to misclassify. FICA payments (Social Security and Medicare) account for 7.65% of an employer’s payroll costs. In Maryland, state unemployment insurance premiums average 7.5% of payroll. Workers compensation premiums can range into the double digits depending on the occupation. All told, cheating contractors can shave 16% off their labor costs – not including workers compensation – when they misclassify. That is a huge advantage in an ultra-competitive industry like construction. Law-abiding employers face a grim choice between holding the line on compensation, cheating themselves or leaving the industry entirely.
State governments can lose massive amounts of unemployment insurance premiums and income taxes due to misclassification. A 2004 Harvard study found that Massachusetts was losing $12.6-35 million per year in unemployment insurance premiums and $91-152 million per year in income taxes. A 2006 University of Missouri-Kansas City study found that Illinois lost $53.7 million in unemployment insurance premiums and $149-248 million in income taxes in 2005. A 2007 Cornell University study found that New York was losing $176 million in unemployment insurance premiums alone per year.
Some states are finally cracking down to recover these lost revenues. Connecticut, New Jersey and Illinois all passed anti-misclassification laws in 2007. Connecticut’s law allows its Labor Department to issue stop-work orders for construction projects with misclassification. New Jersey’s law would send some cheating employers to prison. New York and Washington state both have task forces to assist enforcement efforts. And the Internal Revenue Service has formed partnerships with state authorities in California, Michigan, New Jersey and North Carolina to track down misclassifying employers.
How much money is Maryland losing due to misclassification? No one knows. Peter Franchot told the Mid-Atlantic Regional Council of Carpenters when he was a candidate for Comptroller last year, “Misclassification costs the State of Maryland millions, maybe billions of dollars.” If Harvard found that Massachusetts (a state with a similar population size as Maryland’s) was losing $104-187 million per year, it is conceivable that Maryland’s losses are in the same neighborhood. Why wouldn’t every politician in the state want to have a hard estimate of these losses, especially before voting on tax increases?
Even if Maryland could recover its losses due to misclassification, that would not raise close to the amount of money that a sales tax increase could. But a serious effort to crack down on cheating employers would show the public that their elected leaders understand that tax enforcement is at least as high a priority as tax hikes. And if the state ever did get the problem under control, perhaps the more regressive elements of the current deficit reduction plan could be scaled back over time.
Adam Pagnucco is the Assistant to the General President of the United Brotherhood of Carpenters and has been employed in the labor movement since 1994. The views in this column are his alone and do not represent official statements from the union.