Cornell University

July 26 2010

Tax Dodge Hurts Taxpayers

ILR study on misclassified workers referenced in report to federal policymakers

An ILR worker misclassification study continues to inform decision-making on a key national employment policy issue.

In a 2007 study, The Cost of Worker Misclassification in New York State, ILR's Linda Donahue, Fred Kotler and Ryan Lamare found that billions in unpaid tax dollars would be recouped if workers were not misclassified as independent contractors by employers.

Their work is referenced in a Congressional Research Service report, Tax Gap: Misclassification of Employees as Independent Contractors, issued July 6.

Written for members of Congress by public finance specialist James L. Binckley, the report states that federal, state and local taxes could be reduced if revenue lost to misclassification was reclaimed.

The ILR study found that in the Empire State alone, underreported taxable wages for unemployment insurance averaged more than $4 billion annually from 2002 through 2005.

As one of the study's authors, ILR Senior Extension Associate Donahue explained misclassification's hidden costs during hearings held earlier this year by the New York State Assembly and New York State Senate Committees on Labor.

During her testimony, Donahue said that the practice harms business, government, taxpayers and workers. "Responsible employers are underbid by cut-throat competitors" enjoying an unfair competitive advantage, she said.

Federal, state and local government lose billions in revenue while Unemployment Insurance and Workers' Compensation funds are shortchanged. Additionally, workers are "stripped of many protections," she said.

"Across the nation, unscrupulous employers have learned that the risk of incurring penalties is slight while the benefits of limiting liability, cutting labor costs, and gaining a competitive advantage because of those reduced costs are enormous," Donahue said.

"It's simple math – an employer that isn't paying unemployment insurance, workers' compensation, or Social Security taxes; isn't providing vacation, sick or other leave; isn't offering health care coverage … is going to be able to underbid an employer who is incurring those socially-responsible expenses," she said.

Workers classified as "independent contractors" do not receive legal protections reserved for "employees." These include coverage under laws governing wages and hours, employment discrimination, collective bargaining, as well as workers’ compensation and unemployment insurance.  

According to Donahue, "Many misclassified workers don't realize they have been misclassified. Those that do understand the implications are often silenced by recessionary realities. In this economy, especially, workers just want to get hired – without regard to whether or not the proper taxes are being withheld from their paychecks."

The Cost of Worker Misclassification in New York State is available at http://digitalcommons.ilr.cornell.edu/reports/9/.

It was written by Donahue; Kotler, an ILR lecturer and research associate, and Lamare, who earned his Ph.D. from ILR in 2008.