Millions of Construction Workers Are Illegally Misclassified, Costing Government, Taxpayers $22 Billion in Lost Revenues
By THE CENTURY FOUNDATION – December 18, 2023
A pernicious employment practice—called misclassification— is used by unscrupulous employers to avoid paying their share of payroll taxes and to evade certain responsibilities and liabilities covered by employment law. In some industries, misclassification has become so extreme that it has gone underground, with employers not even formally classifying many workers even as independent contractors, but rather paying them through cash-only, off-the-books transactions or payments to intermediaries and shell companies.
The costs of worker misclassification and off-the-books payments are enormous, particularly in the construction industry. This report finds that, nationally, 1.1 to 2.1 million construction workers are estimated to be misclassified or paid off-the-books, and there are reasons to believe this may undercount the true extent of the problem. These workers lose key legal rights when employers misclassify them or pay them off the books.
Moreover, misclassification and off-the-books payments have significant costs to individual workers through lost worker’s compensation insurance, unemployment insurance (UI), and lost overtime pay. state and federal government social insurance programs also rely on employer taxes for funding.
By misclassifying workers or paying them off the books, employers avoid paying their share of taxes to programs such as Social Security and unemployment insurance. This report estimates that unscrupulous employers in the construction industry that misclassify or resort to off-the-books payments are underpaying workers and shortchanging payments toward legally required benefits (such as Social Security, unemployment insurance, and workers’ compensation) by more than $12 billion per year, costing taxpayers between $5 and $10 billion per year.
Misclassification is an especially egregious illegal labor practice that has far-reaching consequences. Most directly, it denies workers their rights under state and federal law, including the right to overtime pay, minimum wage, certain workplace safety protections, paid family and medical leave and other mandated benefits, a discrimination-and-sexual-harassment-free workplace, and collective bargaining.
Workers misclassified as independent contractors are also denied access to critical social insurance benefits, such as workers’ compensation insurance coverage if they are hurt on the job and unemployment insurance benefits if they are laid off. And their employer’s decision to misclassify them means that the business effectively pushes their Social Security and Medicare tax burden—the “employer share”—from their books onto the backs of the workers themselves. Beyond this, the use of off-the-books payments removes workers entirely from many of the rights and benefits that employees or independent contractors have. Meanwhile, law-abiding businesses often find it difficult to compete with unscrupulous employers that reduce their labor costs substantially via illegal means, and taxpayers are out billions of dollars due to what is essentially an implicit subsidy of public money to employers that knowingly violate the law.
Decades of reporting from across the country suggest that the U.S. construction sector is awash in worker misclassification. But the problem goes even deeper than the decision of whether to hire workers as independent contractors rather than employees. Instead, a substantial portion of the construction workforce now operates in the underground economy, with many employers hiring them through cash-only, off-the-books employment relationships that cast aside any pretense of the formality (or documentation) of traditional independent contracting. This process of misclassification and off-the-books payments is aided by the presence of “labor brokers,” who are effectively unregistered middlemen capable of recruiting and employing legions of construction workers on a jobsite on short notice and who operate in the world of cash payments and check-cashing services.
No Healthcare Safety Nets
Many construction workers operating in this underground cash economy are low-paid immigrant workers. This is unsurprising, considering that an estimated 23% of the construction industry is composed of undocumented workers. Since undocumented workers are less likely to report labor violations due to their status and fear of retaliation, certain segments of the construction industry have become notorious for rampant worker misclassification and exploitation.
Construction is a notoriously dangerous vocation, and workers are regularly injured on the job. Absent the security provided by employer-sponsored health insurance or workers’ compensation coverage, injured workers and their families too often must rely on public services for medical care and financial survival. A 2022 study from the UC Berkeley Center for Labor Research and Education found that not only are construction workers three times more likely to lack health insurance than all workers, but their families are also more likely to rely on public safety net programs due to the deterioration of job quality in the industry. In sum, the study estimated that 39% of families of construction workers are enrolled in at least one safety net program, costing taxpayers nearly $28 billion per year.
The cash-only nature of employment has also made the construction sector a hothouse for wage theft. In many cases, this means requirements that workers operate “off the clock.” In other cases, workers often report working for weeks only to have the employer or labor broker simply refuse to pay the promised amount of money. In extreme cases, it is not unheard of for the employer or labor broker to simply skip town with their workers’ money, never to be heard from again. And all of this occurs as law-abiding employers struggle to remain competitive in some corners of the industry, and taxpayers implicitly subsidize the unscrupulous employers making millions through their unethical and illegal actions. Systemic Fraud Misclassification and off-the-books payments are ways to commit payroll fraud in the construction industry. Also to blame are under-resourced enforcement agencies, insufficient penalties, the use of shell companies and other complex schemes by employers to avoid detection, increased subcontracting and the absence of joint liability affecting developers and general contractors, and legislative aversion to workers’ rights issues. But one significant obstacle to public policy initiatives has been the difficulty in quantifying the incidence and economic costs of worker misclassification. In other words, motivating political action requires assessment of how many construction workers are directly affected and how much the practice of misclassification harms workers, taxpayers and law-abiding contractors.
Legislative & Legal Action
The most direct evidence of the extent of worker misclassification in the non-organized sector of the skilled construction trades comes from the publication of the results of employer audits conducted by a state government’s labor agency in their oversight of state unemployment insurance programs. These audits explicitly attempt to identify employers’ actions to misclassify workers and underreport worker income to state agencies. For example, two recent reports examined UI audit data provided by state agencies to conclude that 8.4% of the construction workforce in Rhode Island was misclassified, while that number was 6.6% in Massachusetts. Meanwhile, reports in these states and elsewhere across the country in the 2000s and 2010s regularly suggested that worker misclassification in the construction industry was well above 10% of the sector’s workforce. A 2021 study published by the Catholic Labor Network demonstrated that nearly half (47%) of the 79 workers surveyed on various large commercial or public construction sites in Washington, D.C., were either paid in cash or via a check without payroll deductions taken out. These results echo three older but much larger jobsite surveys administered by the Workers Defense Project. Surveying hundreds of workers, researchers discovered a 32% misclassification rate across six Southern cities (2017 report), a 41% rate on jobsites across Texas (2013), and a 38% rate in Austin, Texas (2009).
The analysis here uses estimates of income underreporting to tax agencies by self-employed construction workers as a proxy for the extent of illegal employment, an approach fully described in the 2020 ICERES report and a follow-up 2021 ICERES report on worker misclassification in Massachusetts. Using this methodology results in a projection that there were likely between 1.1 million and 2.1 million construction workers that were either misclassified or working in the underground economy on a national basis in 2021; that equates to between 10% and 19% of the industry workforce. Researchers at the Center for New York City Affairs contend that the proportion of construction workers who identify as “unincorporated, self-employed” on Census surveys is another good proxy for misclassification. In the 2021 American Community Survey (ACS), this amounted to 14.7% of the national construction workforce.
Finally, it is important to note that the methodology used for this report is an attempt to estimate misclassification and off-the-books payments in the construction industry, which includes both blue-collar tradesworkers as well as white-collar professionals and support staff. As such, these results should be seen as lower-bound estimates of rates for tradesworkers, given the presumption that misclassification occurs more frequently with blue-collar workers than other workers in the industry. Even within the skilled trades, there are huge disparities in the extent of illegality. For example, while there are reports of misclassification and off-the-books payments affecting every type of construction (industrial, commercial, and so on) a 2021 study revealed that worker misclassification and off-the-books payments in the construction industry is more heavily concentrated in residential construction and in four key occupations: painters, laborers, roofers, and carpenters.
About the authors: Published in November 2023, the writers were: Laura Valle Gutierrez, a fellow at The Century Foundation, Russ Ormiston, an associate professor in business and economics at Allegheny College; Dale L. Belman, a contributor and emeritus professor at Michigan State University; and Jody Calemine a senior fellow and director of labor and employment policy at The Century Foundation.
This report was edited due to space limitations. For the full report, go to https://tcf.org/ content/report/up-to-2-1-million- u-s-construction-workersare- illegally-misclassified-orpaid- off-the-books/