The largest government infusion of cash into the U.S. economy in generations – the 2009 stimulus – was riddled with a massive labor scheme that harmed workers and cheated unsuspecting American taxpayers.
At the time, government regulators watched as money slipped out the door and into the hands of companies that rob state and federal treasuries of billions of dollars each year on stimulus projects and other construction jobs across the country, a yearlong McClatchy investigation found.
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 federal government, while cracking down on the practice in private industry, let it happen in stimulus projects in the rush to pump money into the economy at a time of crisis.
Companies across the country avoided state and federal taxes and undercut law-abiding competitors. They exploited workers desperate for jobs, depriving them of unemployment benefits and often workers’ compensation insurance.
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Exactly how much tax revenue was forfeited on stimulus projects isn’t clear. This is: The government enabled businesses bent on breaking the rules. Regulators squandered the chance to right a rogue industry by forcing companies’ hands on government jobs.
The scheme persists in federal contracting, while government officials acknowledge the mistreatment of hourly wage workers and steep losses to the U.S. treasury.
The result? 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.
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.
But when American tax dollars are at stake, as with President Barack Obama’s economic stimulus package, few in government even talked about the problem, let alone prevented it.
McClatchy’s analysis of payroll records for government-backed housing projects shows the federal government losing billions in tax revenue each year from the construction industry alone – and at a time when states and the nation can ill afford it. As a result, the culprits win, the U.S. treasury goes wanting and workers are left toiling without a safety net.
To understand the national scope and impact of the scheme, McClatchy spent a year reviewing payroll records for federal housing projects in 28 states obtained under the Freedom of Information Act and state public records laws. Most of the projects were paid for in part with stimulus money.
Reporters from eight McClatchy newspapers and its Washington bureau, along with ProPublica, a nonprofit investigative news organization in New York, also visited work sites, spoke with hundreds of workers and dozens of company owners, and interviewed economists, union leaders, policymakers and some of the highest-placed government overseers in Washington.
The investigation found:
– Companies using stimulus money routinely snubbed labor law and the Internal Revenue Service by treating workers as independent contractors in a clear violation of what’s allowed.
– The scofflaws undercut the bids of do-it-right competitors who refused to push their roofers, painters and electricians off their payrolls and into limbo.
– Laborers got swindled. They lost unemployment insurance and, in many cases, workers’ compensation benefits and fair wages. Some didn’t even know they were being hurt.
– All this happened under the noses of government officials. From the White House down to county-level agencies, regulators could have stopped it. Some top government officials admit they didn’t.
The scam is so simple it can be done with the scrawl of a pen. Here’s how it works for companies doing public business:
The companies declare on a routine form that the hourly wage earners working for them aren’t employees, as laws and several federal regulations require them to be, but rather are independent subcontractors. Those companies then don’t withhold income tax or file payroll taxes. They don’t pay unemployment tax. And they aren’t obliged to provide workers’ compensation.
The temptation is obvious: less hassle, big savings. Scofflaws can save 20 percent or more in labor costs by treating employees as independent contractors.
The practice exploits workers and cheats the government of tax revenue; it also runs afoul of a host of labor laws and IRS regulations.
No single factor determines whether a worker must be an employee. McClatchy reporters showed samples of the payroll records to more than a dozen current and former labor investigators, IRS auditors and lawyers who handle labor disputes. They all doubted that company owners would be able to justify treating the workers listed there as independent contractors.
Those working to rid the construction industry of misclassification were astonished this practice passed muster on federal jobs.
“So we the taxpayers are paying the tax cheaters who are exploiting their workers and stealing work from law-abiding employers?” said Matt Capece, a lawyer with the United Brotherhood of Carpenters and Joiners of America, after reviewing payroll records collected by McClatchy.
“No wonder the bad guys are running roughshod over the industry,” he said.
‘No one told me I was wrong’
Obama stepped into office as the nation teetered on the verge of what he called an economic “catastrophe.” At his first prime-time news conference as president, he urged Americans to embrace the power of big government.
“This is not your ordinary, run-of-the-mill recession,” the president said. “We are going through the worst economic crisis since the Great Depression. The federal government is the only entity left with the resources to jolt our economy back to life.”
He signed into law the American Recovery and Reinvestment Act of 2009, known as the stimulus bill, the largest government-spending program in generations. Money began to flow to community projects across the country.
To do business with the government, companies had to file certified payroll records each week to prove they were paying their workers prevailing wages as required by a 1930s-era labor law called the Davis-Bacon Act. The feds establish pay rates for each job in each community.
That paperwork offers a window into the business practices of construction companies: Does the company consider its workers employees? Bosses must list taxes withheld from employees’ pay; for contractors, they don’t deduct taxes.
For companies that treat workers as contractors, the space to list deductions on the records is blank. Some owners scribble in explanations: “pays own taxes” or “1099,” the name of a tax form given to independent contractors.
“I didn’t think I was doing anything wrong,” said Lazaro Villar, who owns a painting and drywall company in Homestead, Fla.
To win a bid painting a low-income housing project in South Florida in late 2012, Villar said, he had to keep his costs low.
He shaved some expenses by pushing taxes onto his workers and forgoing unemployment tax. He took the government’s silence as permission.
“No one told me I was wrong,” Villar said. “The general contractor never told me I was doing anything wrong. The housing authority never told me.”
Losers far outnumber winners
Week after week from 2009 through 2012, tens of thousands of laborers came to work on government jobs hoping to make a decent wage. It was the duty of government officials to ensure the workers weren’t swindled, and to make sure other taxpayers don’t have to pick up the slack.
Thousands of these workers, however, were paid off the books or told they were self-employed, a status that forces them to bear more of a burden in payroll taxes. Many don’t pay, or settle only a fraction of what’s owed. Some of these workers whom McClatchy interviewed say they’re content to stay in the shadows, off the radar of the regulators who could force their bosses to treat them as employees.
The federal government says it collects only a fraction of the taxes owed from the self-employed workforce; by comparison, it captures nearly all it’s owed from employees of companies.
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.
Sen. Charles Grassley, an Iowa Republican, said the payroll reports and McClatchy’s findings showed that the White House wasn’t minding its own store.
“This would be an administration talking out of both sides of their mouth,” Grassley said.
For years, the Department of Labor in Washington has been sharpening its rhetoric about companies that cheat on the backs of their workers when it comes to private contracts. A section of the agency’s website is filled with news releases touting its efforts to curb misclassification. The agency calls the practice “alarming” and “unfair” and describes the workers as “vulnerable.”
When it came to teaching local officials how to enforce labor laws on stimulus jobs, however, federal labor officials said little. At a daylong training seminar streamed over the Internet to more than 5,000 community officials monitoring payroll records in 2011, a labor official spent less than 15 seconds describing the practice and offered no instruction on how to stop it.
Regulators knew the potential for companies to cheat workers on stimulus jobs. The Department of Labor devoted $80 million in stimulus funds to ensure workers were paid prevailing wages on these projects. In the past, the department typically waited for workers to come to it with complaints; for the stimulus projects, it decided not to.
In 2010, a team of 33 experienced investigators picked 51 stimulus projects to inspect for wage violations. Over the ensuing four years, the agency collected more than $10 million in back pay owed to 6,500 workers cheated on wages for those projects.
Of all 1,278 investigations that Labor Department wage and hour officials opened for stimulus projects from 2010 to 2013, investigators found wage and hour violations 62 percent of the time.
Not eight blocks away, their counterparts at the U.S. Department of Housing and Urban Development distributed stimulus money to thousands of companies to build housing for the poor. Only a few of these projects had federal labor inspectors checking behind the local officials HUD trained to spot wage violations.
Jared Bernstein, former chief economic adviser to Vice President Joe Biden, said the administration was serious about confronting misclassification and had taken steps to address the practice on federal contracts. He pointed to the executive order Obama signed this summer, after McClatchy reporters began sharing their findings with administration officials, that forbids federal agencies from doing business with companies that have histories of labor problems. The order also forces company owners to tell workers in writing if bosses consider them to be independent contractors.
“So firms that misclassify under this new executive order should be at a distinct disadvantage when it comes to getting federal contracts. I think that’s an important advance,” Bernstein said.
The rules for the order are still being written, and it’s not clear to regulators whether it would cover contracts such as the nearly 200 housing projects McClatchy reviewed.
So many have much to gain by misclassifying workers. Contractors make heftier profits. Workers get jobs. Consumers get cheaper homes.
But the losers far outnumber the winners. Taxpayers are picking up the tab while cheating businesses prosper. Many honest employers are struggling.
By making the decision to wrongly classify workers as independent contractors, bosses open the door to other abuses: on overtime pay, on workers’ compensation insurance, on unemployment benefits. Some workers interviewed by McClatchy complained of kickbacks, in which they had to return some of their wages to company owners.
Some workers say they kept their mouths shut rather than risk losing a paycheck.
Dale Whitten earned $20 an hour painting rooms in an affordable housing development in Kansas City, Mo., according to payroll records. He should have gotten $41.75 an hour in pay and benefits.
Whitten knew he should be an employee, though his boss considered him an independent contractor.
Whitten was resigned, though, saying he was “just happy to be making anything.”
‘It’s so prevalent everywhere’
The problem is worst in the South, where an absence of unions and prevalence of immigrant labor appear to exacerbate it.
In North Carolina, misclassification costs state and federal governments more than $460 million a year, according to McClatchy’s estimates. In Texas, it’s even more costly, with $1.2 billion lost. Even in Florida, where state regulators have tried to curb bad business practices in recent years, some $400 million is being lost from the construction industry alone.
Still, it happens all across the country. McClatchy’s analysis found that more than 14 percent of the companies submitting payroll records on 23 projects across the U.S. that were examined didn’t withhold the taxes employers are obliged to deduct from employees’ pay. In Kansas City, nine of the 25 companies hired to rehabilitate low-income apartments filed forms that were blank for payroll deductions or reported that their laborers had received 1099 forms.
In Los Angeles, a trio of brothers who rehabilitate housing on military bases said they were treated as independent contractors and forced to pay kickbacks to their boss for the right to work. In Colorado, a crew of five carpenters working on a low-income housing overhaul in Denver were treated as independent contractors.
“It’s so prevalent everywhere,” said Catherine Ruckelshaus, general counsel of the National Employment Law Project.
The construction industry rests on the backs of small operations. Most of the companies – 68 percent – have fewer than five employees, according to census data.
Some of the cheating contractors whom reporters interviewed are unsophisticated and said they didn’t know they were breaking the law. Others know they’re walking a thin line but feel justified doing it.
Harry Hutchins, the owner of Hutch Construction Inc. of Wilson, N.C., hired six men to do carpentry work in 2011 at a low-income apartment complex west of Charlotte.
Hutchins didn’t consider them employees, explaining on payroll forms that each worker “pays own taxes.”
Federal regulations say that if Hutchins is going to exercise control over these workers and dictate how they do their work, they must be his employees.
Hutchins said he wasn’t in charge. “I don’t pay these people this kind of money to baby-sit them,” he said.
On payroll reports, Hutchins is also listed. As a supervisor.
The feds use another test to figure out whether someone is an employee or an independent contractor: Independent contractors negotiate their own compensation and offer bids that help cover the operating costs of their businesses. Hutchins paid his workers $9 to $20 an hour.
Hutchins said he knew the rules on employment and followed them.
“I don’t try to beat the system,” he said. “We stay within the confinements of what they say we can and can’t do.”
Hutchins said he couldn’t understand why competitors would find his practices unfair. He said they should just work harder.
“What are you supposed to do, sit there and whine?” Hutchins asked of his competitors.
‘It’s a free-for-all’
Brian “Andy” Anderson of Mesquite, Texas, knows how to hustle.
For years, it paid off. After 12 years in the steel and rebar business, his company had 80 employees. In the first year of the recession, though, he had to drop to 20. Soon he couldn’t even keep a core group of 14 busy.
Anderson felt a glimmer of hope in February 2009 when he turned on the news to see Obama announce a lifeline in the form of a stimulus package. Through the summer, though, his company’s bids on dozens of stimulus projects yielded nothing.
A review of federally funded housing projects in Texas shows a third of the companies that won federal housing jobs treated their workers as independent contractors – not employees, as Anderson did.
Anderson now suspects that the money he spent on unemployment insurance, workers’ compensation insurance and the employer’s share of Social Security and Medicare cost him those jobs.
Knowing why he lost – by following the government’s laws – frustrates him.
“Here in Texas, it’s just anybody can do anything at any time,” Anderson said. “It’s a free-for-all.”
The local officials who could catch the problem don’t. In Houston’s housing authority, for example, about 25 percent of the workers on two projects McClatchy examined were misclassified.
Brian Gage, a senior policy adviser to the Houston Housing Authority, said his staff didn’t pay any attention to tax withholding, which would signal whether a worker is an employee or independent contractor. He said his staff simply checked hourly rates and trusted that contractors were doing right by their tax obligations.
“I’m not sure we want to get into any IRS business,” Gage said.
Whose job is it?
Misclassification isn’t news to Washington officials. For at least a decade, administrations agreed on this much: It’s a big deal with severe consequences.
But no one in Washington is willing to take the blame for its prevalence.
In 2009, the Government Accountability Office issued a report on misclassification, criticizing the Department of Labor and the IRS for failing to coordinate and find violators. It even identified federal contracts as a potential magnet for companies that misclassify. The Labor Department and the IRS agreed to explore ways to share information more often, but agency barriers remain, several former employees say.
Labor officials are told how to refer cases of misclassification to the IRS, but nothing requires that they do, labor officials said.
And a major blind spot remains on federal contracts, said Jacque Riordon, a former IRS assistant special agent in charge of the Denver field office.
The reason is simple. No one specifically directs federal agencies to watch out for companies skirting labor laws by treating employees as contractors, Riordon said.
“You would think that common sense would lead you to believe . . . it should be done, but it’s not what happens,” Riordon said.
Investigators under several administrations have tried but failed to weed out misclassification.
Efforts by Wage and Hour Division investigators have waned and waxed with administrations. Investigations dropped dramatically from 49,521 a year in the middle of the Clinton administration to 25,852 on the eve of the recession and Obama’s election. They’ve slowly increased since 2010, and last year a team of a thousand investigators completed 33,146 probes into labor law violations.
From 2010 through 2013, labor officials say, they recovered $23.6 million in back wages for nearly 27,000 employees classified as independent contractors in violation of the Fair Labor Standards Act.
On stimulus projects, labor officials directed their attention to monitoring prevailing-wage violations. In those same four years, labor investigators opened 1,278 cases of possible prevailing-wage violations on stimulus projects. They opened 5,355 prevailing-wage cases on government projects that didn’t involve the stimulus.
David Weil, an economist who’s the new head of the Wage and Hour Division at the U.S. Department of Labor, knows investigators face a major battle.
“In some industries, it starts becoming practice as more and more people are playing the game,” Weil said in an interview this summer. “Getting that back in the bottle, I think, is a tough thing. You have got to be strategic about it.”
Weil wrote a report for the Department of Labor in 2010 in which he detailed ways to spot scofflaws. He said investigators needed to target troubled industries more intensely and to go after companies that hired middlemen to obtain misclassified workers. Weil said his agency must, however, be able to rely on investigators in other federal agencies to detect and address the problem.
Weil’s agency knows federal projects are ripe areas for misbehavior. Earlier this summer, investigators wrapped up a two-year investigation into labor violations that robbed more than 90 employees of wages at a federally funded low-income housing development in Detroit.
Those in the private sector are skeptical that regulators will get it right if they try to fix the problem.
“Unfortunately, D.C. has a wonderful ability to do more harm than good when trying to fix problems that sometimes exist and sometimes don’t exist,” said Brian Turmail, spokesman for the Associated General Contractors of America.
‘Not a fair playing field’
The stimulus was supposed to be the lifeboat that kept foundering companies and beleaguered workers afloat during the recession.
In many ways, it was a gift to neighborhoods across the nation. People in dilapidated houses seized grants to seal their homes against the winter’s cold. Workers repaired more than 40,000 miles of roads and more than 2,700 bridges. Poor, isolated communities got Internet service for the first time.
Across the nation, affordable housing projects for low-income residents, stalled because of the stagnant credit market, got the push needed to pay thousands of construction workers.
Sandie Domando and Michael Gillette of Miami vowed to do almost anything they could to ensure some of their employees were among them.
Concrete Plus Inc. shaved bids to razor-thin profit margins and went after 20 government projects. The company usually landed 80 percent of the jobs it sought; on stimulus bids, though, it won just a third.
In the recession’s slow stretches, when the company had to lay off employees, Domando boiled. She suspected unscrupulous companies were winning the work.
“With those government jobs, it’s just not a fair playing field,” Domando said. “And that means that the tax money that we’re paying in – that everybody’s paying in – the government isn’t spending it on the people that need it.
“They’re giving it to companies that aren’t following the rules.”
Yamil Berard of the Fort Worth (Texas) Star-Telegram, Nicholas Nehamas and Evan Benn of the Miami Herald, David Raynor of The News & Observer in Raleigh, N.C., and Mike McGraw of The Kansas City (Mo.) Star contributed to this report.