Did Corruption in the Construction Trades Blunt the Impact of Obama’s Stimulus Package?

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[1]. 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:

  1. 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.
  2. PRIVATE COMPANIES. Developers leverage money for financing to build housing, roads and bridges; general contractors are hired to execute developers’ plans.
  3. (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.
  4. (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.

How significantly?

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 — the savings from pushing taxes onto workers can be the difference between winning and losing a contract.

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.

Second, taxes are not collected that should be:

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.


[1] 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.

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About Lambert Strether

Readers, I have had a correspondent characterize my views as realistic cynical. Let me briefly explain them. I believe in universal programs that provide concrete material benefits, especially to the working class. Medicare for All is the prime example, but tuition-free college and a Post Office Bank also fall under this heading. So do a Jobs Guarantee and a Debt Jubilee. Clearly, neither liberal Democrats nor conservative Republicans can deliver on such programs, because the two are different flavors of neoliberalism (“Because markets”). I don’t much care about the “ism” that delivers the benefits, although whichever one does have to put common humanity first, as opposed to markets. Could be a second FDR saving capitalism, democratic socialism leashing and collaring it, or communism razing it. I don’t much care, as long as the benefits are delivered. To me, the key issue — and this is why Medicare for All is always first with me — is the tens of thousands of excess “deaths from despair,” as described by the Case-Deaton study, and other recent studies. That enormous body count makes Medicare for All, at the very least, a moral and strategic imperative. And that level of suffering and organic damage makes the concerns of identity politics — even the worthy fight to help the refugees Bush, Obama, and Clinton’s wars created — bright shiny objects by comparison. Hence my frustration with the news flow — currently in my view the swirling intersection of two, separate Shock Doctrine campaigns, one by the Administration, and the other by out-of-power liberals and their allies in the State and in the press — a news flow that constantly forces me to focus on matters that I regard as of secondary importance to the excess deaths. What kind of political economy is it that halts or even reverses the increases in life expectancy that civilized societies have achieved? I am also very hopeful that the continuing destruction of both party establishments will open the space for voices supporting programs similar to those I have listed; let’s call such voices “the left.” Volatility creates opportunity, especially if the Democrat establishment, which puts markets first and opposes all such programs, isn’t allowed to get back into the saddle. Eyes on the prize! I love the tactical level, and secretly love even the horse race, since I’ve been blogging about it daily for fourteen years, but everything I write has this perspective at the back of it.


  1. ArkansasAngie

    As a “honest” contractor this particular concept pisses me off.

    A couple of points:

    Workers are often quite angry if you withhold from them. They don’t want no stinking tax form. It is NOT just undocumented aliens who don’t want to pay their taxes.

    The owners aren’t making more money … you said they won the contract by coming in with a lower bid.

    The insurance companies … general liability and workers’ comp … require that companies have coverage. If you don’t provide coverage because you are using sub contractors, you MUST have a copy of the sub contractors’ policies. Insurance companies do police this. I am audited regularly. Highly unpleasant.

    1. diptherio

      I’ve commented on this a couple of times. 1) There is extreme competition among sub-contractors for most jobs. If you want to continue working at all, you have to cut costs as much as possible. The same thing goes for general contractors. 2) As noted by McClatchy, and as you allude to, construction laborers don’t make a whole lot of money, in general, and so often are happy to work “under the table” so as to avoid payroll taxes and to maximize their take-home pay. 3) Having official employees is expensive. Expenses are bad–see point 1. For many subcontractors (at least the small ones like my crew) the “owner” is also one of the laborers. Often enough, the owner is making no more, sometimes even less, than the rest of his/her crew. Misclassification, to be blunt, is an straight-up necessity for most of the subcontractors I work with.

      The real problem, I think, at least in my neck of the woods, is that it is damned expensive to run a small business. The large contractors and subcontractors might be able to afford to do everything on the up-and-up, but most small contractors simply cannot. Universal health care would take care of a part of those expenses, and make small businesses more manageable, but even then the rabbit-warren of regulations and fees from the state level that one has to deal with to be “legit” are both intimidating and insulting. So many of us do without.

      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.

      And there’s the rub–classifying these workers correctly will have the effect of lowering their wages. Misclassification is a benefit, often, to both the employer and the employee. The subcontractors in my field who do have “employees” pay them minimum wage. Those of us who feel our time is worth considerably more, end up being 1099’d.

      I know the situation is different for large subs using migrant labor, but the misclassification issue is a lot less clear-cut than how it is often presented (including here).

      1. jsn

        Good comment. I don’t know what field you’re in, but my experiences are similar. I have worked to all the formal rules and since 2008 it has killed my company. I’ve now taken a job with someone else after 18 years running my own business.

        The incentives are all wrong because the “stimulus” is dumped into a “market” with vast asymmetries between those entities that can qualify as “government contractors” and everyone else. There is politics in that to begin with, then, once scale is achieved issues like 1099ing employees disappear from the local enforcement regime while for “non-govt contractors” it remains front and center: I know, I was one. Thus those of us not hooked to the teat of State maintain downward labor cost pressure which then incentivizes the whole private sub-contractor labor market to look to what Lambert called System D yesterday to support declining standards of living.

        There is a much bigger problem embedded in the macro system somewhere between Lambert’s System D post yesterday and this one. The economic pressure of declining wages is forcing more an more Americans into black-markets: System D. This has the effect of criminalizing an increasing portion of the population. Those critical of what is becoming a mass phenomenon need to think carefully about which side of the “eat cake” divide they sit on.

        1. ArkansasAngie


          Quite frankly ,,, I think it is moronic to ask anybody making less than $30,000 to pay taxes. Collect from them to give it back to them? Horse manure.

          And worker’s comp … many can’t pass the piss test that workers’ comp requires. So I pay for something that they won’t get. Honestly don’t believe health insurance should come from employers.

          Hourly rate plus 17% workers’ comp plus 6% unemployment plus 7% SS == 30%. A machine is cheaper. and they don’t have girlfriends or sick babies or get drunk.

        2. ambrit

          Amen and a hallelujah too!
          I’ve done my share of “off the books” work to see the degrading nature of this beastie.
          Defining down the workforce is running a large share of the population into a twilight zone where their connection to, and support for the formal economy are fading away. This erosion of identification with the formal economy also translates into a loosening of the ties to the formal government too. When one finds themselves being treated like dirt, it becomes harder and harder to resist the urge to show those on top just what real ‘dirt’ is.
          During the Depression days, a social Robin Hood movement arose. People like Dillinger and Bonnie and Clyde, who were really ruthless criminals, became folk heroes simply for “standing up to” the formal power structure. More constructive social arrangements also arose. These, being less flamboyant, did not receive equal attention, but they were there. A mix of the two trends resulted in “Bonus Marches” that scared the Establishment enough that it experimented with socialist policies, simply to save Capitalism from itself.
          All this makes me appreciate the Stoics more and more as time progresses. Where oh where is our Marcus Aurelius? Instead we get a series of Neros.
          One of the better employers I worked for was, to be frank, “connected” to the power elite of his region. As the ‘clean up man’ for this company, (there were two of us, but the other man was better qualified for the heavier commercial aspects of the job,) I did my share of ‘courtesy’ repairs and small additions for local movers and shakers. (The cue was when the boss would pull you aside and say something to the effect of, “Don’t worry about how long it takes. Just do a really good job. Understand?”) I remember one remodeling job that turned into a nightmare, (old house refits trend that way,) and when it was all over, I was standing in the boss’ office waiting to get chewed out. [I knew it had been way over budget.] The boss comes in and says, “Good job. You made them very happy.” “Oh”, was all I could say. The boss started laughing. “You should see your face!” We exchanged ‘knowing looks’ and I went home.

      2. jonboinAR

        It seems to me that the current necessity for the small sub to misclassify is all due to that Gresham’s Dynamic dealie. If none of y’all were doing it or getting away with it, none of you would have to misclassify, but once some of you started getting away with doing it, the rest of you had to fall in in order to compete. This problem could be solved, I should think, by enforcement of regulations. It wouldn’t have to be completely disruptive. Declare a provisional amnesty. Unless you get caught misclassifying 3 months from now forward, you’re past misclassifying is forgiven, won’t be investigated. If you do get caught after that forward date, buddy you’re in trouble. That seems like plenty of forgiveness to me. All contracting prices will go up by some amount, probably. So be it.

        Your argument that somehow implies that the worker needs, for his own finances, to be misclassified, is a bunch of self-serving nonsense that’s beneath you. Wages are determined more by supply and demand. I’ve spent my whole life in construction. Being paid cash doesn’t make a worker feel more secure for long. When you’re in that position you realize that you’re not much more than the little red tag flapping at the end of a traveling load of lumber, waiting to fall off and be instantly forgotten.

      3. MtnLife

        Around here the reason for so many subs is getting f*cked over repeatedly by the big guys. When I left my last place of employment the supervisors/foremen were barely making $20/hr for building multimillion dollar homes and high end custom furniture. $20/hr is what a furniture makers apprentice makes, not the guy in charge. Turnover grew as the owner kept cutting salaries costs and through worker replacement has a payroll paradigm shift. While this may have been a boon at the start, soon the lack of skilled/experienced crew members stalled/extended projects and in the end became far more costly. To honestly pay people for what they did before they left he should have been paying near double what he was. There is only one large contractor left who has the respect of the workforce in the area. Everyone knows if they end up with someone else it’ll most likely be abusive and barely make ends meet.
        There’s another issue in our state and that is the law that says if someone subs for us for more than 3 out of 5 days per week (over some relatively small extended period of time) that you have to hire them as an employee. While I understand the protective benefits for the workers from a large corporation, it is just shooting all your small businesses in the foot. I have been wanting to bring on help but I’m at the point where I don’t have quite enough extra business to put someone on and I can’t bring them on for just a bit to help without being sucked down by the excessive costs of hiring your first employee. So instead of giving people the opportunity to make SOME money by sharing some of the work I’ve got, they get stuck on public assistance because even that temporary work is too costly for small employers. The only other option is to rotate your subs and as long as you keep pay under $400/person total, it does not have to be reported. As diptherio mentioned, most are happy to work under the table for $15/hr. Even with variable work loads it tends to beat spending 40+ hrs a week at a minimum wage job.

        1. jonboinAR

          To me it seems the only solution, from the workers perspective, is unionized labor combined with labor-law enforcement. I want everyone to understand something, no one is “happy” to work for $15 an hour, cash. Beats a poke in the eye with a sharp stick? Well, yeah. I guess it does that.

          1. Ulysses

            X1000! This “independent contractor” scam is a huge issue for truck drivers as well. It explains how FraudEx gets away with paying Home Delivery and Ground drivers less than half what the Teamsters who drive for UPS get paid, for exactly the same work, before even getting into pensions, health benefits, etc.

    2. John Zelnicker

      Of course they don’t want a tax form and withholding. No one likes to pay taxes, but, seriously, who’s the boss? If you explain that they pay more taxes as a 1099 independent contractor than a W-2 employee, they might realize it is to their advantage to be classified correctly. (I know it is more expensive for you, the owner.) In addition, legally you cannot deduct the amounts paid to workers if you don’t provide them with the appropriate tax form and report their income to the IRS and state tax authority.
      The big difference in classification for the worker is that she has to pay both the employer and employee portions of Social Security and Medicare taxes.

      1. ambrit

        I’ve been there. That’s why so many small tradesmen and women will hint at “pay me in cash” on the first date.
        Also, $15 an hours worth depends on where you live and your expense load. Commuting can eat your lunch. I’ve turned down decent jobs over exactly that issue.

      2. Whine Country

        I’m from out west. It is very easy to pay no taxes on 1099 income if you know the ropes. When a boss explains to a worker who is determined to not be an employee, they will not buy the argument that they pay more tax. In the first place the IRS cannot legally assess self-employment tax as part of the under-reported income collection process, so it is very easy to just pay the income tax (which you would pay anyway). There is a separate process for collecting self-employment tax and, as a practical matter, I am not aware of the IRS ever using it. (The reason being that the IRS knows full well that the person should have been classified as an employee and the do not want to open up the can of worms of why they let the employers get away with it while focusing on the little guy) So, very worst case, the worker pays only the income tax he would have otherwise paid and no employment taxes, which is considerably less than if classified as an employer. In Arizona where I now live, worker classification is take it or leave it. Nothing to discuss. Want a job? You are whatever the employer says you are. Much simpler that way. BTW, I’m a retired CPA who practiced many years as a tax specialist in California, so this is not just street talk.

  2. Bill Smith

    But in the end it is the workers who should have been employees but where instead contractors who cheated and didn’t pay their taxes? Did the companies send the 1099’s to the IRS and the employees? If not, how did they get away with that?

    1. ArkansasAngie

      I certainly send 1099’s. And … that is one of the problems for folks wanting to go legit. They can’t because of the back taxes they owe.

    2. tomk

      I’m wondering the same thing. I’m a carpenter sometimes working on a payroll for $20, or getting $35 as an independent. Working on my own I will get a 1099 if I work more than a few days on a particular job, which means I can’t easily avoid paying taxes on that income. I have to have liability insurance, but on the other hand I can deduct my job related expenses.

      I’m sure on large projects this issue is huge, and needs enforcement, but on a smaller local level, as Diptherio noted, the issue is that it is extremely expensive and difficult to properly operate a small business with a handful of legitimate employees, even if you’re only offering them the mandated benefits of Worker’s Comp and Unemplyment Insurance.

      What happens when a misclassified worker gets badly hurt and has no Worker’s Comp? That must bring some unwanted attention to the issue. Or do the general contractors cover it out of pocket, not so much because it’s the right thing to do, but to avoid bringing that attention?

      1. ArkansasAngie

        Spoken … yet unwritten rule … you are fired before you hit the ground.

        General carpentry workers comp here is 17%.

        I have historically MADE everybody be an employee. I’m thinking of firing the whole lot and going sub contracting because of the expense of employees AND the headaches of employees. Substance abuse. Employee screws up … I pay for it. Sub contract screws up and I don’t pay him till its done right.

        1. Pwelder

          Angie – readers who don’t know the industry might not pick up on the fact that the 17% you cite is 17% OF PAYROLL – which is a huge burden for the law-abiding operator if the situation allows for cheating. And for some of the trades (roofers, ironworkers, etc.) the rate is a LOT higher.

          My own company in the Northeast (from which I retired a couple of decades ago) had collective bargaining agreements with all the trades, and since we didn’t have much non-union competition we didn’t have this particular issue. But it boggles the mind to think that somebody out there is not paying their workmen’s comp. The reason rates are high (the main reason, anyway) is that accidents happen. What happens when the comp isn’t being paid and a serious accident occurs? Seems to me that contractors who would put themselves in that position are volunteering for bankruptcy and jail time – they’d have to be real kamikazes.

          My naivete here comes from the fact that we were working mainly industrial plants and process lines. The customers had full-time contracting officers, and so the flakes and the crazies tended not to get in the door.

          1. ambrit

            I once had to file a Workmans Lien against a subcontractor who hired me ad hoc to fix up some screw ups his crews had left on a multi-townhouse project. I got stiffed when I presented my bill. I had already paid my helper, each Friday over the several weeks of this job, and was, to say the least, feeling the pinch.
            I walked up to the desk in the Parish Clerk of Courts office dealing with such issues and plunked down my paperwork. The first thing the lady said was; “Oh. Him again.”
            As I navigated the labyrinth of the Parish offices I learned that this man was famous for such actions. He changed the legal ownership of the company anytime a major problem arose. (I was too small to count.) This company had changed hands numerous times over the years, always ending up belonging to one or another member of his extended family. His trucks were never parked on a public street. (The repo men can’t come on private property to repossess without a court order.) His heavy equipment was always locked up in someone else’s garage or warehouse.
            Finally, a friendly clerk looks around and tells me to refile the lien and include the general contractor as a defendant. “That way, the General will offer you half the claim just to get his name off of this filing.” That worked, and I ended up with a check from the General for half of my claim, and a check from the sub for the other half. Guess which check bounced.

          2. ArkansasAngie

            Roofing is 34%. I never do roofing.

            Besides being moral … it is the liability of somebody getting hurt that scares the cr** out of me. I seldom go a day without having to have a discussion on liability.

    3. Whine Country

      You mean that they might not collect SS benefits from the fund scheduled to go broke when they are about to retire? That is, of course, if their benefits are not greatly reduced or eliminated when that date comes? I think they are pulled irresistibly by the bird in the hand argument in today’s economy.

  3. John Zelnicker

    Lambert — A couple of corrections re: taxes:

    “If you’re filling out a 1099 when you should be filling out a 1040, that’s misclassification.” It’s a 1099 vs. a W-2. Every taxpayer fills out a version of the 1040.

    “Workers treated as independent contractors report only a fraction of their pay to the government.” That is only possible if the company does not send the 1099 to the IRS. If they send it, the IRS will match it to the tax return to see if the taxpayer reported at least that much income. If not, the IRS will correct the return and demand more taxes, plus penalties and interest.
    Otherwise a great post. I’ve been a tax professional for over a dozen years and the construction industry is absolutely the worst for misclassification.

      1. John Zelnicker

        Of course. However, if they don’t file, the IRS will create a tax return for them based on the 1099’s with no deductions or credits and bill them for the taxes, with penalties and interest. Although many of the non-filers have nothing really to lose since they are generally among the working poor, having the IRS after you is no fun and can cause problems in the future if, for instance, they start working as an employee where the IRS can garnish wages. Also, an IRS tax lien wreaks havoc on one’s credit score and cannot be discharged in bankruptcy.

        1. jonboinAR

          Someone I heard about used to get paid actual green cash, plus a check for which you were going to get a 1099 matched up with at the end of the year. The cash part was the “underground economy”. It was partial. This was many years ago. They were sure they were all going to get in a bunch of trouble eventually, but they never did, from the government. From living that way, however, they probably now have no pension or savings to speak of, and wish they’d never done it.

        2. Paul Tioxon

          I’ve have seen this scam where the job requirements were for an “independent” contractor. The 1099s are supposed to be reported to the government by the hiring employer. For this to be the underground economy tax avoidance, the employer and the employee together must not report to the government. The employer and the employee must completely lie and hide 100% by not reporting 1099 issuance and the independent contractor must not file any taxes. At this point, I have no sympathy for the liberty loving small businesses as well as the liberty loving tax cheats. These guys are not as smart as they think they are. A small business, and it can be a $5mil per year in revenues, eventually will want to retire to Boca or where ever. Can he sell his consistently money losing business because he has made tax avoidance the primary activity of his accounting practices? You have a tough time getting full value for business you want to cash out of after a lifetime of blood, sweat and lying to everyone about the extent and profitability of the business. You close the door and walk away with the cash you hid away and get nothing in return for the business you ran as a tax avoidance operation instead of enterprise which could retain marketable value after you retire and sell it.

          The worker, who pays no self employment taxes because he spent a lifetime as a 1099 independent contractor, would have to hide a lot of cash somewhere, someway in order to have income at the point of his retirement. Social Security is not an option with not enough quarters of work reported and enough contributions. I am finding it hard to believe that these cheap skates even bother with 1099s, but just pay under the table all of the time. Why bother with the trip to Staples to get a form, if everyone is lying about it anyway? If the business man is reasonably honest, he reports the 1099 amount to the IRS, the independent contractor then takes every deduction in the world to knock this down to as close to nothing as possible on his tax return, even lying about a new truck or some other form of accelerated depreciation.

          Because of payroll taxes and worker comp insurance, a lot small businesses find the path of least resistance in going 1099, not because workers demand, but because it reduces total labor compensation costs. Placing as much distance as possible for being held responsible for the livelihood of another American with the excuse that they don’t want to be bothered with taxation adds to the rationalization, that nobody wants the government’s enforced burden of record keeping paper work and the taxes that go with it. At some point, everyone involved can’t help but be in agreement with this self reinforcing attitude of disintegrating all social relationships and live in a sub culture of lying as new found individual freedom. Enter the tri corner hat wearing rugged individuals with their scoped rifles to protect the hamburger rancher on Federal Lands. Patriots all against tyranny! Free at last, Free at last, Great God Almighty, Free At Last!!!

          1. jonboinAR

            As I said above, it seems that Gresham’s Dynamic business forces everyone to have to do it. In that case, wouldn’t the solution be labor law enforcement? All of this, as with that financial control fraud stuff that Yves and others have documented so well, appears to me to be due to a failure to regulate effectively.

          2. Whine Country

            Where do you stand on the IRS budget? I began practicing as a CPA, specializing in tax matters, in 1972. Then, the IRS had the budget and authority to vigorously enforce the issue of independent contractors v. employees, like all of the tax laws. Now retired, I often represent friends and family in matters related to 1099’s. If you want to know how things work, I can tell you this, you will never see in writing how it really works because, like so many things today, the laws are not enforced. I use the skills I learned over many years now to help my family and friends (for free!) so that they do not become the victims of arbitrarily enforced laws.The IRS knows at every level I deal with exactly what I am doing. It is not a secret, and I am always treated with the same respect that a partner in a DC law firm would get. And why wouldn’t that be? I am playing the same game as the DC law partner. I agree that it is disheartening to hear of others breaking the rules and getting away with it when you don’t. (How about them Banksters for instance?) But yesterday I noticed an article on where are all of the unemployed? Obviously when you see an article like that you realize that too many of us don’t know the answer of how they and the many millions of our part- or marginally- employed neighbors get by. Well here is part of the answer. Is this there first choice? Not in my experience. It is what they have to do to keep the wolf from the door. (In Arizona, where I live now, you either take what the boss offers or leave it for another identical offer) The lesson for today’s time is you can have all the laws in the world on the books (we are approaching that point soon), but if you do not enforce them, you get what we have – every man for himself. Your anger is understandable, but your feeling about those who have to do what they have to do should cause you to be shocked, just like Captain Renault in Casablanca.

            1. jonboinAR

              That’s my intuitive sense, as well. It appears, on face, to be a problem that can first be attacked by enforcing current laws and regulations. Again, if enforcement is spotty or nonexistent, then probably no small contractors can afford to hire legit, because they will be undercut by those who don’t. The solution would probably involve reviving the labor unions in combination with effective and consistent enforcement of the law.

            2. Paul Tioxon

              My stand on the IRS budget is the same as my stand with the Social Security Budget. The Federal Government has been hollowed out by decades of elimination of the internal capacity of the government overall, to have in house experts, in house longstanding institutional knowledge transmitted from decade to decade. Right now, almost 100 Social Security field offices have been shut down, due to budget cuts. Most business is driven through their web site. This may be news, but 65 years olds and computer compatibility are not near 100%, the way it is with 21st Century kids, 14 year olds who were born after the internet was commercialized and extensively being used.

              I have a cousin who worked a lifetime in the IRS and got the same response about the cutbacks and enforcement. It is at a very low level. You can see the attacks against the IRS by R Congressman Issa who has fabricated a charge of IRS retribution against God Fearing Americans who want to operate the national slush fund for elections, tax free. This gets no traction what so ever, because no ones business is confiscated, no one loses their home or life savings or goes to jail like a murderer for failure to file or pay a tax under extreme conditions. The old 60 Minutes horror stories of the IRS parachuting out the air like Seal Team 6 to take down a some one who made a decimal point error or math mistake on their 1040 are not as widespread because no one is left to do the widespread auditing that keeps the majority in line out of fear that they are next.

              The Federal Government has undergone liposuction beyond the point where now bone marrow and connective tissue is being removed, since so much much of the fabled waste, fraud and abuse has fallen simply by cutting off staff and general funding to rip that much off anymore. I believe people should only be paying for social insurance like Social Security and Medicare, not income taxes. Business that operate for a profit should be shouldering the income tax burden, because they are machines of profits, unlike individuals whose salaries and wages are fixed percentages of the input costs of production.

          3. ambrit

            I agree mostly, but must quibble as regards relative strengths of the actors here. I’ve seen this dynamic play out on multi-million dollar commercial projects. As in, the first thing out of the Generals mouth when he introduces himself to the workforce being; “We don’t want to hear anything about unions or other s— like that. You all got jobs, be happy with that. Understand me?” [I was there the day that was said in front of about two hundred workers.] This was also the job where the water tower split open during the static test and poured about twenty thousand gallons of water into the building through the Tire, Battery and Accessory entrance. Luckily no one was hurt. It turned out that the subcontractors responsible for the tower construction were low ballers and had one other tower do exactly the same thing the year before because they had cheaped out on the grade of welding rods used in the tower skin construction. [This company was still building towers two years later.]
            A lesson in the corrosive effects of the Greshams Dynamic in construction. It starts with the bookkeepers and ends up in the graveyard.
            I digress.
            My takeaway from this is that, through the 1099 scam, the responsibility for the tax avoidance is being dumped on those least able to fight back, the workers.
            One thing the Unions, or what’s left of them, can do would be to set up legal help centres in urban centres across the nation to help those being victimized by this giant scam. It would not only help set right a social wrong, but also show the ordinary working people a tangible benefit related to the union movement. If, as we saw after Katrina, ‘faith based’ entities could subtly evangelize through doing good works, so can the Unions.
            Nuff said.

            1. Paul Tioxon

              I agree. I was trying to not attack anyone who simply owned a business. But again, they are both in collusion and it starts with the business owners. I don’t believe a business runs itself by the demands of the hired help that wants to be paid under the table. Labor does not dictate to management, when someone else can be hire to fit the needs of the business. The terms of employment are flowing from the one that does the hiring. That would be the owner or management. Still 3 or 4 people for every job opening out there. I don’t see the political equation favoring the independent contractor. I don’t see the independence in this type of arrangement either. You are still dependent upon selling yourself for a paycheck. Just what are you independent from?

          4. ArkansasAngie

            They don’t file ANY tax returns. Zero.

            And yes the taxes owed and interest and penalties pile up … but they don’t care.

  4. NotTimothyGeithner

    Since corruption and/or waste are inherent to any new endeavor, none of this should be unexpected, and once again the size and structure of the stimulus along with the lack of taxes which are a useful way of stemming corruption (see Al Capone) are the story, not the unique character.

    A government program to investigate besides the stimulate effect of hiring investigators would have reduced corruption just by being. In many ways, this goes back to the Obama decision to reward white collar criminals and then run on how tough Obama was on illegals and drug users.

  5. Xelcho

    All of us need to realize that the prevailing wages clauses, in general, only apply to govnt funded projects. Needless to say, this means that this problem of govnt mandated wage rates being significantly above market rates won’t apply to almost all private projects. I mention this as this is the main reason that these games take place.

    If you have enough pull you can get crazy things to happen, like…If you recall post Katrina, Bush pulled the prevailing wage requirement and offered a defacto bonus to biz owners.

    All in all, it really is typical clumsy, arrogant and notorious corruption not unlike what we see in the FIRE sectors. What is humorous is it there is big biz in performing the verbal acrobatics and economic quantum mechanics used to explain it away as the best and only way forward.

    1. ambrit

      Also, prevailing wages can be different for different projects, for the same job. Not just regional, but locale to locale.

  6. GlassHammer

    Just two things:

    1.) Hasn’t this been going on for well over a decade?

    2.) Haven’t we seen the exact same problem in other sectors of the economy?

    Maybe it has gotten worse as of late but this is certainly not a new problem.

    1. washunate

      Yep. Misclassification is one of the biggest issues in the workplace. The economy hasn’t created any regular jobs for the entire 21st century, and misclassification is one of the primary enablers of the perm to temp trend.

  7. sd

    Talk to smaller local contractors working GSE contracts. An Indian billing company processes payments, They flatly refuse to pay more than 50 cents on the dollar for any and all work. Complaints to anyone in the system who might be interested in addressing the rip off are ignored.

    Needless to say, they cycle through contractors and subs and then just move on to the next mark.

        1. ambrit

          Since these are GSE contracts, (and I’m a bit confused here since GSEs are financial entities, like Fannie Mae and Freddy Mac,) I’m assuming we’re talking about maintenance and preservation work, no? Even so, aren’t there rules mandating that American companies get these contracts? As in, there should be an American front company available for you to f— with?
          This looks like a classic opportunity for someone to bundle a lot of small claims and apply economies of scale to the prosecution of claims. After a general boiler plate claim ‘narrative’ has been thrashed out, endless repetition of same can bring the strongest of insider run scams to their knees. Then, if the Feds step in to ‘level the playing field’ for the scammers, at least the corruption will be out in the open.

  8. Jesper

    I’m guessing it might be considered to be too costly for the judiciary to handle the situation?

    Costs at one end while the benefits arrive at the other and nobody in power sees or cares about the big picture?

    And due to the unavoidable (is it really?) current complexity of the judicial system nothing can be done?

  9. jgordon

    I believe Austrians would call this an example of “miss-allocation of wealth”. Like water is wet and the sky is blue, it is the nature of easy money that most of it is profligately wasted on consumables and trash.

    Of course, that’s also a good thing: money spent that would have genuinely enhanced the industrial economy and “jobs” would have been far worse for the world and our environment than money wasted on trash. Now we can all focus more on getting back to nature and local production sooner, whereas “wise” industrial policy without such (guaranteed) corruption would have prolonged the agony of disintegration somewhat longer than it strictly needs to be.

    Just to be clear, government stimulus = massive corruption + profligate waste. That is like a universal law of failing empires.

  10. washunate

    For contextual purposes, this is a great example of why details matter when one talks about ‘jobs’. Misclassification is nothing new, and it is not something unique to construction. It’s actually a rather minor issue as far as ARRA itself goes, because by definition ARRA was temporary. It personified the very model of temp work replacing permanent, professional positions.

  11. KFritz

    This is actually a state regulation issue. If you read the McClatchy article that’s ostensibly about “California tax cheats,” you’ll see a graphic that compares misclassification in three states–Florida, North Carolina, and Texas.

    The level of cheating is inversely proportional to the strength of contractors’ license law. You can see the strength of license laws with this link, which is available at Craigslist ‘Skilled Trade’ category (at the bottom of the page): “http://www.contractors-license.org/”

    The level of enforcement at the state level is another key component. If the state yanks a contractor’s license for violations, that’s a very strong tool. Many state regulatory agencies are understaffed and overworked.

    And sorry for the tangential rant, but A POX on Craigslist for moving the information links to the bottom of the page, where Craig, et al know damn well they’re less likely to be seen.

  12. frosty zoom

    always the same mantra: “private good, public bad”.

    so why isn’t the WORLD’S FINEST MILITARY privatized?

    why can’t we just construct the things ourselves? (i know “why”)

    1. ambrit

      Leaving aside the “finest military” bit, haven’t you noticed how much of what the army used to do for themselves is now in the hands of ‘private’ contractors? How about, food service, cleaning and maintenance, supply and transport, etc.

      1. frosty zoom

        public = 17% inefficiency
        private = 15.2% inefficiency PLUS 7.9% profit

        why doesn’t anybody do the math? (i know why)

        then there’s the PRIVBLIC™. goes well, they earn. goes badly, we pay.

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