Is Big Business Getting Bigger By Cheating?

Over the past half year, I have commented on the congressional investigation into Blackwater's gambit for enriching its owner--treating hired security personnel in Iraq and elsewhere as though they were independent contractors.  See Blackwater Security Guards (Mar.12, 2008) (discussing Waxman letter to IRS, Small Business Administration and Labor Department pressing for inquiry into Blackwater classification of employees); Blackwater Security Guards (Oct. 20, 2007) ( discussing Waxman letter to Blackwater's Prince seeking information about classification of employees).  That gambit saves the company millions, enriches the company's owners (in Blackwater's case, on no-bid government crony contracts), and leaves the little guy--the company's employees--out in the cold because the company doesn't even pay Social Security on the wages. 

See this WorldWideWeb-Tax posting on the difference between employee and independent contractor.  The key factor in making the determination is how much the company controls the employee.  And what about the consequences of the determination?  It can make a big difference in how much the company pays in taxes and in what benefits the employee receives.  The following is a quick overview from PayrollTaxes.com.

What difference does it make to classify a worker as an independent contractor instead of as an employee? Here are some of the requirements of an employer/employee relationship:

• Employee Withholding. Employers are responsible for the withholding and timely remittance of federal income taxes, state and local income taxes, and FICA taxes from wages paid to their employees.
• Employer Payroll Taxes. Employers owe, and must remit, their own share of payroll taxes, such as FICA and federal and state unemployment insurance, on employee wages.
• Labor Laws. Worker's compensation, working condition, and minimum wage laws all impose on employers certain financial and other requirements for the benefit of employees.
• Employee Benefits. Employees generally enjoy employer funded benefit programs such as vacations, holidays with pay, health insurance, and pension and profit sharing plans; contractors generally do not receive these benefits.
• Reporting. Wages paid to employees (along with the amounts of the various taxes withheld) are reported on Form W-2; amounts paid to contractors are reported on Form 1099. Additionally, Forms 940 and 941 (and perhaps others) must be filed for wages paid to employees.

So the worker definitely loses out when the employer misclassifies the worker.  But that isn't the only loss.  In effect, when an employer misclassifies an employee, we all lose--the worker, the employer's competitors (who are trying to make a profit while treating their workers with respect, as they should), and the public fisc.  See this entry on the unbossed.com blog.

The IRS ruled in the case of one Blackwater employee that the employee was just that, and not an independent contractor.  Hopefully, it is auditing Blackwater diligently and will assess acequqate penalties for its failure to treat its employees as such. 

Blackwater isn't the only big company with saving millions by pretending that its employees aren't.  FedEx is another one, as revealed this week in a story in the New York Times looking at the miserable result for one woman truck driver for Fed Ex.  See Steven Greenhouse, Working Life (High and Low), New York Times, April 20, 2008.  You can also check out FedEx's online recruitment information for single and team ground haulers at this link.  (You'll probably note that it doesn't leave much up to "negotiation" with its "independent contractors"--there are set rates, performance bonuses, times for work for singles versus teams, and various "discount programs" for buying gas at FedEx,etc.--sounds a little like the company store and coal mine job that Tennessee Ernie Ford used to sing about.)  According to the story, Jean Capobianco drives a truck for Fed Ex.  She was required to buy a particular truck, on terms set by Fed Ex.  She is required to wear a FedEx uniform.  She reports to work at the time FedEx instructs her to.  She loads and delivers the packages that FedEx instructs her to deliver.  She appears to be, in all practical details, an employee.  Yet she bears most of the risk of her job, and FedEx gets most of the benefit.  Instead of making the $60,000 that FedEx advertises for its drivers, she makes slightly over $32,000 after all those costs foisted on her by FedEx are taken into account.  And the benefit for FedEx.  It avoided about $400 million (a year), giving it a huge advantage over UPS, its competitor that treats its employees as, surprise, employees.

In 30 lawsuits, FedEx Ground drivers have argued that they are employees, not independent contractors, and that the company should therefore pay for their trucks, insurance, repairs, gas and tires. In one lawsuit, a California judge ruled that FedEx Ground was engaged in an elaborate ruse in which FedEx “has close to absolute control” over the drivers. Last December, FedEx acknowledged another setback: the I.R.S. ordered it to pay $319 million in taxes and penalties for 2002 for misclassifying employees as independent contractors. FedEx could face similar I.R.S. penalties for subsequent years. FedEx said it would appeal.  Id.

How common is this?  In New York State, an article by Donahue, Lamare and Kotler suggests that there is a significant underground of companies--especially construction companies--that misclassify their workers--averaging around 10% or more.  See The Cost of Worker MisClassification in New York State.  Other studies suggest that as many as 30-40% of workers may be misclassified.  See this posting on the IRS Mind blog (reporting a 1984 IRS study showing about 15% and a review of about eleven thousand 1988-1994 audits, suggesting more than 40%).  The IRS finally issue, in December 2007, Form 8919, a form that facilitates a worker's claim that its employer failed to pay over payroll taxes appropriately. 

In that context, the fact that the IRS has cut back on its audits of big corporations is again problematic. (See TRAC data on the significant drop in corporate audits by the IRS.)   And the fact that Congress seems bent on providing more and more corporate welfare through the tax code is even more ludicrous.  (See the proposal for a 4-year carryback of operating losses for construction companies and others, letting companies that over-speculated in housing get paid for their risky behavior by the taxpayers.)  Perhaps instead Congress should enact a legal presumption that new hires are employees, unless an employer can demonstrate that the new hires are clearly independent contractors.

Get with it, IRS.  Audit these businesses and require them to treat their employees as employees.  It's time to do what's right, instead of creating a climate where anything goes for big business.

Comments

[andy]

"in Blackwater's case, on no-bid government crony contracts"

"more and more corporate welfare through the tax code is even more ludicrous."

"It's time to do what's right, instead of creating a climate where anything goes for big business."

for whatever it's worth, the over-the-top statements on this blog tend to detract from your arguments rather than support them. i wonder what purpose is served by them. if the goal is to vent, then that's one thing, but it's distracting to try to go through a substantive post and then keep getting hit with hyperbolic statements.

[John]

Andy: Just a quick note. I think the "crony" label fits. Blackwater is led by Eric Prince, brother of Betsy (Prince) De Vos. She is married to Dick De Vos of the Amway fortune - big Republican contributors. Betsy is past chair of the Michigan Republican Party. Dick ran for Governor in 2006. He lost in a landslide after it was disclosed that he (as CEO) sent manufacturing jobs to China.

[andy]

John: whether or not the label "crony" fits (I have no idea), I think e.g. the progressive/libertarian case for a presumptive-employee rule can be made (and can be made much more strongly) without frequent resort to overstatements.

Using overbearing language just means that the people who already agree with you will agree with you more, and that the people who might possibly be persuaded will be turned away by the empty rhetoric. I just don't understand why it's done in this context (i.e. where there are strong critical/substantive points to make), unless one is just trying to vent.

[John]

Ever read anything by Tom Paine?

[LindaMBeale]

Andy,
You say that it is "hyperbolic" to use what I believe to be an objectively accurate term "crony" to describe a relationship between a particular contractor (Blackwater) and the current regime in power through which that contractor has acquired lucrative contracts and has at the same time characterized its workers in ways that are disadvantageous for the employees but advantageous for the employer for tax purposes. John's response to your comment highlights a few of the reasons the crony label is appropriate.

I agree with you that reading blog posts that insert extraneous opinions into a substantive discussion can be irritating. But I strongly disagree with the notion that pointing out the cronyism problem in this context is that kind of extraneous opinion.

In fact, it is a point that is terribly important to be made in the tax policy context: policies that are easily captured by such crony relationships present genuine justice concerns. The potential for crony ripoffs is one of the reasons thathaving a default rule (that workers are employees)is a good idea. Such a rule makes it harder for crony contracts to yield as big a benefit.

You know, of course, that these kinds of marred relationships are the topic of significant scholarship as well. Public choice theory, among others, considers such contexts. I question a good bit of the "law and economics" approach (since I think many of the most interesting questions are assumed away), but I do think the analysis of policy decisionmaking is important.

So, from my blog perspective, which is one that is interested in considering the interrelationship between appropriate tax policy and sustainable democractic institutions, cronyism is a substantive issue that we need to think about. To disregard it (by not mentioning it) is to hide it under the fig-leaf of arm's length transactions, which is, at least sometimes, a truly misleading characterization.