By Lambert Strether of Corrente.
McClatchy has published an impressive multi-part, multi-newsroom investigative report, “Misclassified: Contract to cheat,” covering construction spending in seven states paid for by Obama’s stimulus package. While there has been controversy over the size of the package, and over how Larry Summers structured Obama’s options for decision-making, there has been little mainstream coverage of how Obama’s stimulus package played out in the real economy, except in terms of its results, which were mediocre at best. McClatchy’s series has changed that, or should.
The key concept is “misclassification.” The series explains:
A review of public records in 28 states uncovered widespread cheating by construction companies that listed workers as contractors instead of employees in order to beat competitors and cut costs. … The problem known as misclassification is so well-understood in the U.S. economy that government has vowed to fix it for years. Federal investigators have hammered private companies doing private work, collecting millions in back wages from restaurateurs, nail salon owners and maid services.
To over-simplify: If you’re filling out a 1099 when you should be filling out a 1040, that’s misclassification. There are regulations to detect misclassification, and it is, in fact, illegal, as we see.
McClatchy conceptualizes the problem as a “broken pipeline,” listing a series of steps:
- GOVERNMENT STIMULUS. Washington sent $840 billion to communities across the country to jump-start construction projects – and the economy. Federal funds flowed as businesses earned contracts and workers made money.
- PRIVATE COMPANIES. Developers leverage money for financing to build housing, roads and bridges; general contractors are hired to execute developers’ plans.
- (Where it leaks.) SUBCONTRACTORS. Subcontracting firms are hired to paint, lay bricks, hang drywall. Some follow the law and treat workers as employees; those companies collect and pay nearly all the taxes owed to Uncle Sam. Other companies treat workers as independent contractors, leaving it to them to settle their taxes.
- (Where it leaks.) WORKERS. Workers treated as independent contractors report only a fraction of their pay to the government. And, the companies that hire them don’t pay unemployment taxes or the share of payroll taxes employers owe.
The “leaks” happen when subcontractors misclassify workers. (Obviously, the workers can’t misclassify themselves.) While theoretically, only the Federal government can classify workers, in practice the subcontractors are unregulated, so if they write “1099” on a worker’s contract, that’s how the worker is classified, and that’s what the subcontractor reports to the government.
Why is this important? Because misclassification creates a Gresham’s dynamic among the subcontractors:
Concrete Plus went after contracts for 20 jobs with state or federal funding, mainly projects to build or improve low-income housing. It won just seven, well below the company’s usual rate of success.
And Domando says she knows why: “We were getting underbid by companies that were cheating.”
The scheme is simple: Instead of treating workers as regular employees, companies classify them as independent contractors. That way, the companies don’t have to withhold income taxes from their workers’ wages or file unemployment taxes. Their labor costs are significantly lower than companies like Domando’s that obey the law.
Scofflaws can save 20 percent or more in labor costs by treating employees as independent contractors.
That’s a lot! And the key point:
On government jobs, wages are fixed according to the Davis-Bacon Act, a 1930s-era law that provides fair pay for workers. Since wages are a set cost on Davis-Bacon projects — the same for every company — .
So that’s the Gresham’s dynamic; cheaters prosper. McClatchy frames the consequences of misclassification “leaks” in two ways. First, workers are gouged:
[M]isclassification breeds other schemes as company owners clamor for an advantage over competitors. Companies may dodge prevailing wages required by the Davis-Bacon Act, a 1930s-era law that mandates fair wages on federally backed projects. Workers are sometimes cheated on hours or overtime pay. They may be paid cash under the table, pushed into an underground economy. Some workers interviewed by McClatchy, like Barreda, complained of kickbacks, in which they had to return some of their wages to company bosses.
“Generally, violations do not occur in isolation,” said Julie Su, the California labor commissioner. “You uncover one violation and it’s often a doorway into multiple violations.”
McClatchy’s review of payroll records shows immigrants are most susceptible to misclassification and other exploitation. Using the records as a starting point, McClatchy found and interviewed hundreds of laborers and tradesmen. Many, in addition to being misclassified, told unsettling stories of mistreatment:
- Companies refusing to provide tax forms that allowed workers to file tax returns.
- Bosses forcing workers to pay a fee to use protective gear such as hard hats and steel-toe boots.
- Bosses refusing to settle up on days’ or weeks’ worth of pay.
- A workplace injury without any insurance to take care of it.
“It makes me feel invisible,” said Camilo Loyola, a Mexican immigrant who moved to North Carolina more than 20 years ago. During two decades in the construction industry, Loyola has been shortchanged on wages and deprived of tax forms, he said. In 2011, he worked on a government-financed project in Raleigh and was improperly treated as an independent contractor. He knew it was wrong, but he needed to keep the money flowing for his family.
In Florida, a McClatchy analysis shows nearly $400 million a year in squandered tax revenue from construction firms and their workers. In North Carolina, nearly $500 million a year. And in Texas, a staggering $1.2 billion.
Construction workers don’t make much money, and one by one their tax evasion doesn’t amount to much. But misclassification has become an industry standard, McClatchy found, and the associated cost is staggering.
Nationally, the tax losses amount to billions. If just 20 percent of the 10 million construction workers in the U.S. are misclassified, that tops $8.5 billion each year in federal payroll and income taxes and unemployment taxes, McClatchy estimates.
Those are serious effects, to be sure. But how would they affect the stimulus? Here, as far as data goes, we’re in uncharted waters (again!!!).
But we can proceed from the general idea that a stimulus is meant to stimulate, and that it does so by getting money into the hands of people who will spend it as rapidly as possible, and on items that are likely to benefit the real economy. For example, if we give a wealthy person a check for $1,000, he might throw it in his desk drawer — since the amount is trivially small — where it might languish for a few months until his personal assistant finds it, and puts it toward an Hermés yacht cover or a Jeff Koons painting. Not that there’s anything wrong with that. (This same process would apply to even a smallish subcontractor, simply because they’re unlikely to be as desperate as out-of-work construction workers, and can hold back their spending until they consider what to do, and will probably not spend on necessities.) But if we give a poor person that same check, they’ll spend it right away at the grocery store, at the auto repair shop, and maybe even on a movie or a meal. Who stimulates the economy more, and faster? (This parable is, I believe, called “the marginal propensity to consume.”) The exception here would be the immigrant (documented or not) who would be likely to send a portion of that check out of the country, to be spent at groceries and auto repair shops, just not here.
So, “misclassification” must have made Obama’s stimulus spending less effective that it would otherwise have been for two reasons:
1) Spending was skewed toward owners, who have a lower marginal propensity to consume. I believe this would be true for two reasons: First, in an environment successfully regulated by Davis-Bacon, the workers get a larger slice of the pie. Second, where misclassification occurs, the social dynamics between boss and owner are such that other violations, like wage theft and kickbacks, follow, and these practices transfer income from workers to owners (“primitive accumulation”).
2) Spending was skewed toward immigrants, who have a tendency to send money out of the country. Here again social dynamics favor those willing to work off-the-books or under the table, for the minimum that desperation demands, and sadly, such workers are disproportionately immigrants.
I don’t think we can quantify these effects, but the order of magnitude from the uncollected taxes would lead us to think in terms of billions of unstimulating stimulus, like a multiplier effect but with one of the terms set to zero. Not trivial!
Misclassification is corruption. (McClatchy goes into detail on how regulators turned a blind eye to the practices, but that’s a topic for another day). I’ve heard the argument made that our government is so corrupt that it’s irredeemable; to expand on McClatchy’s metaphor, any pipeline will be found to be so riddled with holes drilled by thieves and grifters that no water will ever come out the other end; #thirdworldproblem. I happen not to believe that, but stories like this chasten my optimism.
 If the effects had been strong, we wouldn’t even be arguing about them.
General note to McClatchy editors: If any of you are reading this post, the content of this series is wonderful; kudos. However, for this simple blogger, what I take to be a “mobile first” design makes the material incredibly difficult to navigate on the platform I use to create content: A laptop. The multi-story structure is simply too complex and too poorly sign-posted to navigate effectively. Moveover, sometimes essential information is buried in graphics. For example, I tried to find the “Broken Pipeline” graphic by Googling on the word “leak.” Nothing came up, because the word “leak” is in the graphic not the text. And the concept of a pipeline that “leaks” is essential. Even with mobile first, the user experience on the laptop is important. I am not easily intimidated by content. This story intimidated me.