Underground Economy
How much do 'off-the-books' workers cheat on taxes?
By Mary H. Cooper

This year at tax time, law-abiding Americans understandably may wonder if they have been bearing more than their fair share of the tax load lately. Recent news reports suggest that millions of employers and workers are skirting the Internal Revenue Service, among them: nominees to high government office who hired illegal aliens as housekeepers and didn't pay their Social Security taxes; immigrants. . . .

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Are government regulations chiefly responsible for the emergence of the underground economy?

Jeffrey Tucker Associate Editor of the Austrian Economics Newsletter and editor of the Free Market.. From Policy Review, The Heritage Foundation, Summer 1993.	Saskia Sassen Professor of Urban Planning, Columbia University.. From “The Informal Economy: Between New Developments and Old Regulations,” The Yale Law Journal, June 1994.

Hiring a Housekeeper Without the Hassle

Unfortunately for Zo Baird, Judge Kimba M. Wood and a few other Clinton administration nominees, Home/Work Solutions came along too late to help them avoid problems with domestic workers.

But many other families who want to hire housekeepers have turned to the Silver Spring, Md., firm, which was founded in March 1993, as a direct result of Nannygate. The nationwide service even advertises by inviting prospective clients to “get legal” by letting it handle the paperwork associated with domestics employed in the above-ground economy.

“We take care of registering you with the state and federal governments for your employer identifications,” says President Kathleen Webb, “and we work with you to decide which taxes are going to be withheld, particularly income taxes.” Employers are not required to withhold income taxes for domestic employers, but Webb says many do so.

Domestic employment, though it generally involves few skills and low wages, accounts for a relatively large portion of the underground economy. (See table, p. 197.) Thus, the Internal Revenue Service and state financial agencies are eager to bring it into the official economy.

Demographic trends suggest that the demand for domestic workers will continue to grow. As more and more women enter the labor force, families will need nannies and babysitters to care for children during the day. And the rapidly growing population of older Americans also enhances the demand for domestic workers.

“Although better than half of the workers employed by our clients are nannies, elder-care workers are becoming a growing portion of our business,” Webb says. “Many elderly people are having companions live in, and even the adult children of the elderly will pay to have someone live in with their parent to delay the slide into a nursing home.”

Bureaucratic red tape accounts for much of the firm's success, says Webb. Employers of domestic workers must deal with two types of confusing regulations. The first involves immigration laws, which apply because recent immigrants are frequently the main providers of babysitting, gardening and house-cleaning services.

Under the 1986 Immigration Reform and Control Act, it is the employer's responsibility to screen out illegal immigrants, who are not allowed to work in this country. Employers must verify a worker's status by examining a passport or other document, and they must keep records of hiring and termination dates, as well as wages paid. Hiring an undocumented alien is punishable by up to six months in prison and a $3,000 fine.

Employers face even more complicated regulations in complying with tax laws. The IRS requires employers to file forms every three months for the payment of Social Security withholding taxes on any employees making at least $50 a calendar quarter. These taxes, currently 15.3 percent of earnings, are paid by both workers and employers and entitle workers to receive disability and retirement benefits.

A household that pays a worker more than $1,000 during a calendar quarter must also pay a federal unemployment tax. At the end of the year, the employer is required to provide a completed W-2 wage statement for each domestic worker, who must then submit the form as part of the 1040 individual income tax declaration. Failure to file the forms or pay the required taxes carries fines plus the payment of any back taxes and interest. In addition to these federal re- quirements, each state taxes and regulates domestic employment.

For about $200 a year, plus an initial $60 registration fee, employers can hand the whole paperwork burden over to Webb. “Most of our clients are professionals who understand the value of time,” she says. “Rather than spending an hour every quarter putting together the paperwork, they prefer to pay someone to do it for them.”

Sobered by the lessons of Nannygate, many affluent Americans who long have skirted the law are pressing Congress to make it easier for them to legally engage nannies and other domestic workers. Lawmakers have responded to public protests that the regulations involving domestic employment are unnecessarily complex.

Sen. Daniel Patrick Moynihan, D-N.Y., has introduced a bill that would require tax payments only for domestic employees age 18 or older who earn about $610 a month. A less sweeping bill sponsored by Rep. Barbara B. Kennelly, D-Conn., would raise the earnings threshold to $800 a year and exclude payments for employees under 16.

The prospects for passage of either bill this year appear remote. Meanwhile, employers of domestic workers must continue to deal with the current regulatory headaches or find someone to help.

“Most average people who are hiring housekeepers or nannies don't even know where in the government to turn to get the forms and information,” Webb says. “It's not like you can walk into the post office and pick them up. We know what needs to be filed, when it needs to be filed and how to go about doing it. We offer them peace of mind.”

FD For background, see “Child Care,” The CQ Researcher, Dec. 17, 1993, pp. 1105-1128.