Relying on UI wage records to measure employment and income for low-income populations has two potentially serious weaknesses. The first arises because UI wage records do not cover all forms of employment. In particular, state UI systems typically do not cover the employment of self-employed persons, most independent contractors, military personnel, federal government workers, railroad employees, some part-time employees of nonprofit institutions, employees of religious orders, and some students employed by their schools. Therefore, wage earnings from these types of employment are not contained in state UI wage records.
The importance of these exemptions is unclear. In at least two places in the literature, an assertion is made that 90 percent of workers in the U.S. economy are in jobs covered by the UI system (Baj et al., 1991; Kornfeld and Bloom, 1999).(16) As noted in the following paragraphs, this statistic is challenged by the results of Blakemore et al. (1996) and Burgess et al. (1998), but even if true, it is not clear how comforting it should be if the topic of interest is low-wage labor markets. If, for example, 8 percent of all jobs are missing from UI wage records, but all 8 percent are low-income workers (which in turn is a much larger fraction of all low-income workers), the usefulness of UI data in monitoring the effects of welfare reform would be severely eroded.
Blakemore et al. (1996) and Burgess et al. (1998) report results of a fascinating study of 875 Illinois employers from 1987 that were subjected to detailed audits of their UI reports. As part of the data set, routine information such as the employment size of the firm, the statutory UI tax rate for each firm, one-digit Standard Industrial Classification codes, and UI reporting punctuality were compiled. They also have unique audit information on unreported workers, underreported total and taxable wages, and UI taxes due on these unreported wages. They also merged information on the total number of independent contractors that each firm reported to the IRS. The data set does not attempt to identify employers who are part of the underground economy.
If the results for Illinois are projected nationally,(17) employers failed to report the presence of 11.1 million UI-eligible workers and $70.6 billion in wages to state UI agencies in 1987. This is 13.6 percent of all workers. Some of the undercoverage arose from failure to report casual or part-time workers, and failure to report tips, bonuses, or other types of irregular compensation. By far the largest problem (accounting for roughly 50 percent of the discrepancy), however, was with independent contractors. Issues surrounding independent contractors are among the most vexing in tax administration and labor law. In brief (and at the risk of oversimplification), in tax law there is a somewhat subjective, 20-part test to define a worker as a regular employee or independent contractor. Elements of the test include (from IRS Publication 15A: Employer's Supplemental Tax Guide) whether the business has "behavioral control" of the worker (does the business give instructions and train the worker?); financial control (can the worker make a profit or loss, does the worker have unreimbursed business expenses, or does the worker make services available to a broad market?); and type of relationship (does the job have benefits, is it permanent, are the tasks a key aspect of the regular business of the company?). If a worker is treated as an independent contractor, an employer does not have to withhold income taxes, withhold and pay Social Security and Medicare taxes, or pay UI taxes.
It is not clear if the issues raised in the Illinois UI audits are associated strictly with independent contractors (in the technical sense) or more broadly with flexible staffing arrangements. Houseman (1999) provides a nice introduction to issues associated with flexible staffing arrangements. She reports data from the February 1997 CPS Supplement on Contingent and Alternative Work Arrangements showing that 6.7 percent of workers were "independent contractors," 1 percent were "agency temporaries," 1.6 percent were "on-call or day laborers," .6 percent were "contract company workers," and 2.6 percent were "other direct-hire temporaries." These categories compose 12.5 percent of the workforce. The use of flexible staffing arrangements appears to have been growing sharply over time, but detailed information on its growth is not available. Houseman (1999) reports that the IRS estimates it loses billions in tax revenues each year due to misclassification of employees.
Houseman (1999) also reports information on the incomes of "flexible workers" drawn from the February 1995 CPS Supplement on Contingent and Alternative Work Arrangements, matched to the March 1995 CPS. Of "regular" employees 7.5 percent had incomes below 125 percent of poverty. The corresponding figures for agency temporaries was 21.7 percent; 16.2 percent for on-call or day laborers; 10.8 percent for independent contractors; 11.5 percent for contract company workers; and 15.1 percent for other short-term direct hires. Consequently, a failure of UI data to fully capture workers in flexible staffing arrangements could be a major problem for studies that rely exclusively on UI data to measure the income and employment of low-income workers.
In many industries, employers have considerable flexibility in designating the status of workers. At least in the Illinois audit study, employers aggressively overused the independent contractor designation. In all, 45 percent of employers make some underreporting error. This includes nearly 500,000 cases in which workers were excluded erroneously, which resulted in $2.6 billion in wages being underreported. Smaller firms were estimated to underreport 14 percent of their taxable wages and 56 percent of their UI-covered workforce. In statistical models, the percentage of workers on the payroll who are independent contractors and the turnover of the firms' workers are two key explanatory variables. The effective tax rate, while related to turnover, also appears to be positively associated with compliance. The characteristics of firms that make errors on UI reports would appear to be positively correlated with the type of employers who disproportionately hire workers with low levels of human capital.
Hence, we view the Blakemore et al. (1996) and Burgess et al. (1998) studies as raising a serious concern about the coverage of UI data, and hence its suitability as the exclusive source of data with which to evaluate welfare reform. In our conclusions, we recommend that at least one additional study be conducted along the lines of the Illinois study to assess UI coverage. It is our impression, based on casual, anecdotal evidence, that the use of independent contractors has increased fairly substantially over time, and thus the work based on 1987 Illinois data may understate the problem.
The second potentially major weakness with using UI data for evaluating welfare reform is that they contain limited accompanying demographic information on individuals, and, more importantly, may not allow one to form an accurate measure of family income. In assessing the impacts of welfare reform, many argue that it is important to assess how these changes affect the well-being of children and the families in which they reside. As such, families constitute the natural "unit of analysis" for such assessments and family income often is used as an indicator of this unit's well-being.
The potential problem of relying on earnings data from UI wage records when the objective is to assess the level of family resources in studying the impact of welfare reform recently has been highlighted by Rolston (1999). Based on past research, Rolston notes that changes in individual income account for only 40 to 50 percent of exits from welfare. Thus, to have a complete picture of the effects of welfare reform, analysts need information on other economic and demographic changes occurring in the family. Given this, the problem is clear. Income as reported through UI records fails to include sources of nonemployment income and income of partners that is available to a family. Income sources that are not UI data may result in a family not receiving cash assistance or being ineligible.
The calculations from Meyer and Cancian (1998) suggest the concern raised by Rolston (1999) is economically important. Recall that Meyer and Cancian found, for example, that 5 years after leaving welfare, 64.2 percent of the women still have incomes below the poverty line, while, when considering the broader family unit, only 40.5 percent have income below the poverty line. In a related calculation, however, Primus et al. (1999) do an analysis that shows "for most single-mother families, including the income of unrelated male individuals does not materially change the picture drawn of a decline in overall disposable income between 1995 and 1997." More needs to be learned about the importance of the issue raised by Rolston in assessing the level and trend in family well-being following welfare reform.
To summarize, using UI wage records to measure income and employment has two potential weaknesses. These are as follows:
- UI data do not cover all workers, including the self-employed, military, federal employees, independent contractors, and other employment arrangements. Some evidence shows that gaps in coverage may be significant.
- UI data follow individuals, so one cannot get information on incomes of other family members, at least without Social Security numbers of other household members. UI data also provide limited demographic and background information on workers.
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