(1) The Prevalence of Wage and Tax Fraud

Unemployment Insurance Audits

The most direct and compelling evidence of wage and tax fraud in the construction industry comes from state agencies’ audits of employer payroll records. The U.S. Department of Labor requires that representatives from state unemployment insurance agencies audit employers’ records to ensure that workers, if determined to be “employees” and not independent contractors, are correctly classified and that relevant taxes are by paid by the employer.⁸⁵ In the course of these audits, state agencies have frequently uncovered substantial evidence of worker misclassification.

While employer audits have long been required of states by the U.S. Department of Labor, they remained largely out of public view until a 2004 report by Francoise Carrè and Randall Wilson of UMass-Boston. Often referred to as the “Harvard Study,” this report presented the results of employer audits in Massachusetts by the Department of Unemployment Assistance for 2001 through 2003.⁸⁶ The current report updates this landmark 2004 study, featuring the results of payroll audits of construction employers as conducted by the DUA between 2017 and 2019. There are two types of audits included. First, the DUA reviews records from randomly-selected firms from its UI database. Second, the DUA conducts “targeted” audits based on past violations, tips from workers, or other factors. Mirroring the approach used in the 2004 Harvard Study, Table 1 presents the results of both the random audits (first column) and the sum of random and targeted audits (second column).⁸⁷

Table 1. Results of Employer Payroll Audits, Construction Industry (NAICS=23), Massachusetts Department of Unemployment Assistance, 2017-2019

The direct evidence compiled by the agency offers an unmistakable conclusion: wage and tax fraud is widespread in the Massachusetts construction industry. DUA audits reveal that between 16.8% and 17.9% of Massachusetts construction employers were determined to be “misclassifying” at least one worker between 2017 and 2019.⁸⁸ The DUA defines this to include either the improper employ of independent contractors or off-the-books workers.⁸⁹ Firms discovered to be misclassifying did so extensively, with the average offending employer misclassifying between 10.6 and 11.6 individuals; this represents nearly one-fifth of the employees of these businesses (17.9% to 19.0%). Taken as a proportion of legal wage-and-salary employees among all audited firms, the data reflect that between 6.6% and 7.6% of all construction employees in the Commonwealth were misclassified between 2017 and 2019.⁹⁰ Extrapolated to the industry as a whole, this rate suggests that there were between 11,593 and 13,496 misclassified construction workers in Massachusetts in 2019.⁹¹ While DUA audits reveal that worker misclassification is a substantial concern across all industries, the results reflect that the problem is particularly acute in the state’s construction sector.^92,93

Two important trends emerge in comparing the audit outcomes in the current study (2017-19 results) to those from the 2004 Harvard Study (2001-03 results). First, it appears that the proportion of employers engaged in worker misclassification in the Massachusetts construction industry has remained high, increasing slightly over the last 15-20 years. On random audits, only 14% of construction employers were found to be misclassifying in 2001-03; the results in this study indicate this rose to 16.8% in 2017-19.⁹⁴ However, the proportion of each company’s workforce that was being misclassified in the construction sector declined from 40% in 2001-03 to 17.9% in 2017-19.⁹⁵

The data do not provide an explanation for the decline in the extent of misclassification by offending construction firms since 2001-03. It is our view that this result should not be interpreted as a sign of progress, but rather as a warning that the industry has moved even further underground. The experience of Universal Drywall offered in Part 1—the gradual shifting of work from established contractors to labor brokers—is consistent with our many conversations with industry stakeholders in Massachusetts and across the country. In effect, the construction industry has seen a clear trend moving away from independent contractors using 1099-MISC forms (easier to detect in audits) and towards a business model that predominantly depends on labor brokers and cash-only employment relationships (much more difficult to detect).

While our approach in Table 1 replicates the 2004 Harvard Study, the data provided by the DUA allow for a deeper analysis as the random audits are also aggregated for four subsectors of the construction industry.⁹⁶ Audit results for different areas within the construction industry have been rare in state-specific studies and were not included in the 2004 Harvard Study, thereby allowing the current report to add to state and national understanding of worker misclassification.⁹⁷ Sub-sector data provided by the DUA were limited to random audits; the results are presented in Table 2.

Although worker misclassification occurs in all four subsectors of construction, Table 2 reflects that it is more prevalent among residential builders than many other parts of the industry. The results demonstrate that as nearly one in five (19.7%) residential builders misclassify workers with an industry average of 14.0 workers per offending employer; this equates to 14.3% of all employees working in the residential building sub-sector of construction.

Among the specialty trades, Table 2 reveals that misclassification is heavily concentrated among building finishing contractors; this includes drywall and insulation, painting and wall covering, flooring, tile and terrazzo, and finish carpentry contractors. DUA results reflect that more than one in four (26.6%) of these employers engage in misclassification, affecting 15.1 workers per offending company and amounting to nearly one-sixth (16.6%) of all employees in this sector. Misclassification is not as extensive among other specialty trades contractors. Rates are relatively low among building equipment contractors—which includes plumbing and electrical contractors—with just 12.2% of firms engaging in misclassification and just 2.0% of all employees affected. In sum, the results of the Table 2 offer direct evidence that worker misclassification is rampant in residential construction and among specialty trades contractors—such as drywall and finish carpentry—responsible for some of the final stages of residential construction projects.

Table 2. Results of Employer Payroll Audits, Subsectors of Construction (by NAICS code), Massachusetts Department of Unemployment Assistance, Random Audits Only, 2017-2019

Indirect Method: The Full Extent of Misclassification

Payroll audits conducted by the Massachusetts Department of Unemployment Assistance offer direct and compelling proof of widespread worker misclassification in the state’s construction industry. However, audit results under-represent the full extent of wage and tax fraud in the sector for three reasons.⁹⁸ First, the DUA audits employers who pay into the state unemployment insurance system; this would not include direct oversight of labor brokers and other contractors that exclusively hire workers on a cash-only basis.⁹⁹ Second, some forms of wage and tax fraud—especially cash-only payments—are difficult to detect for even the most skilled auditor, especially given the lengths that some contractors go to conceal their actions.¹⁰⁰ Finally, while the DUA attempts to audit firms of all sizes, the completion of an audit on small construction employers—which comprise a substantial portion of the industry—is notoriously difficult.¹⁰¹ Some small business owners cannot be located, others will stall and evade DUA representatives for as long as possible and, in some cases, the company simply disappears.¹⁰² DUA data clearly reflect this problem, and the disproportionate exclusion of small businesses—whose elusiveness presumably reflects efforts to conceal illegality—results in audits likely underrepresenting the rate of illegal activity, an outcome exacerbated by the outsized role of small employers in the Massachusetts construction industry.¹⁰³

Payroll audits represent the only source of direct, quantitative data on misclassification available to researchers. However, because of their limitations, an empirical assessment of the full extent of wage and tax fraud in the industry requires an alternative approach. To resolve this issue, academic scholars have developed indirect methods of estimating the total number of workers who are misclassified as independent contractors or working off-the-books in a state’s construction industry. While approaches differ slightly between studies, they share a common foundation: a comparison of national surveys of workers (e.g., the Census) to aggregated payroll records submitted to state UI programs. Here, researchers consistently find large differences between the number of individuals who self-report as working in the construction industry and the number of employees on contractors’ official payroll records.¹⁰⁴

Researchers contend that the sizeable disparity between data sources reflects the extent of payroll fraud. However, isolating an exact number of workers employed fraudulently by comparing data sets encounters several complications.¹⁰⁵ Although numerous studies have proposed empirical solutions to these problems, each suggested approach has shortcomings that introduce a nontrivial margin of error into projections of worker misclassification. This is an expected outcome, as nearly any study of the underground economy—either in construction or otherwise—suffers from data limitations that complicate researchers’ ability to make accurate estimates of illegal activity. This study is no different. However, we minimize such concerns by applying the most advanced empirical methodology available to assess worker misclassification in a state’s construction industry using publicly-available data: an approach developed in a 2020 study published by the Institute for Construction Economic Research (ICERES).¹⁰⁶ A full review of the methodology, its limitations, and its application to Massachusetts is presented in Appendix A.

Using this approach, we estimate that there were between 22,146 and 36,719 workers who were misclassified as independent contractors or working off-the-books in the Massachusetts construction industry in 2019, equating to 9.5% to 15.8% of the sector’s workforce in the Commonwealth.¹⁰⁷ These estimates climb to 11.3% to 18.8% if considering only blue-collar workers in the construction sector.¹⁰⁸ There is evidence supporting these projections as reasonable, if not conservative.¹⁰⁹ Our industry-wide results in Massachusetts (9.5%-15.8%) are comparable to studies using similar empirical methodologies in other states, including New Jersey (16%), California (16%) and Tennessee (11%-21%); they are also consistent with the national estimates (12.4%-20.5%) reported in the 2020 ICERES study.¹¹⁰ For a full discussion of the reasons supporting the credibility to these estimates, see “Validating the Results” in Appendix A.

While these results are consistent with other data points on payroll fraud, the authors have reasons to suspect that the proposed maximum may understate the full extent of wage and tax fraud in Massachusetts. The first set of reasons are methodological in nature; for details, see “Discussion” in Appendix A.¹¹¹ Second, studies that estimate the prevalence of payroll fraud by surveying construction workers on job sites find substantially higher rates of illegality (consistently over 30%). While surveys often feature small sample sizes and are typically conducted in cities and locations rife with payroll fraud, they offer evidence supporting higher projections of payroll fraud.¹¹²

1099-MISC Filings

As further confirmation of expansive rates of wage and tax fraud in the construction industry, this study examines data on 1099-MISC filings provided by the Massachusetts Department of Revenue. Unfortunately, the data supplied to the authors include only a fraction of all 1099-MISCs issued by employers in the Commonwealth; while firms are required to file their 1099-MISCs with the Internal Revenue Service, businesses are not required to file 1099s with the Massachusetts DOR.¹¹³ The incomplete nature of the data renders it a less effective measure of some employment outcomes, such as estimating the number of independent contractors in the Commonwealth.

Nevertheless, the data provided by the DOR still offer several powerful insights into employment practices and underground activity in the Massachusetts construction sector. Primary among these is that many construction workers who receive 1099- MISC forms never file income taxes with the Department of Revenue. As evidence of this, the DOR data reflect that Massachusetts construction employers issued 24,387 1099-MISC forms to state residents between 2016 and 2019; it is from this group that one would expect workers to file income taxes with the Commonwealth’s Department of Revenue. However, the data reflect that 7,867 (32%) of these forms were issued to Massachusetts residents using Social Security Numbers that did not appear in personal income tax returns submitted to the Department of Revenue in the year the 1099-MISC form was issued.¹¹⁴

There are non-fraudulent reasons that explain some non-filing behavior, suggesting that the 32% number over-represents the rate of tax fraud among these workers.¹¹⁵ However, our analysis of the data and conversations with DOR representatives suggest that these exceptions are not so large as to change the fundamental conclusion that there are thousands of 1099-MISC forms issued to Massachusetts construction workers using Social Security Numbers that do not appear on state tax returns. This outcome is even more alarming considering that the DOR could only provide us access to a fraction of all 1099-MISCs issued in the industry.¹¹⁶ It is unclear in the data why workers may not be filing tax returns; some may be trying to conceal earnings from the DOR, while others may have been using a fake Social Security Number in order to secure work. Both reasons, however, are reflective of underground economic activity and offer further confirmation of widespread illegal activity in the Massachusetts construction industry. For more analysis of the DOR’s 1099-MISC data, see Appendix B.

Workers’ Compensation Trust Fund

Rampant wage and tax fraud in the Massachusetts construction industry is also revealed in an analysis of workers’ compensation cases. Workers’ compensation coverage is required of employers in Massachusetts, however it has become commonplace for non-union contractors to let their policy lapse, forego coverage altogether, or potentially engage in complex fraudulent schemes to minimize policy costs.¹¹⁷ Workers bear a considerable burden as a result of these actions, as they are left without insurance benefits to cover medical bills and lost income should they get hurt on a jobsite. But state law provides injured workers in Massachusetts a potential remedy: the Workers’ Compensation Trust Fund (WCTF) was established to provide benefits for workers who have approved claims while working for employers who are uninsured in violation of state law. Summary data on WCTF claims is published annually by the Workers’ Compensation Advisory Council.

The WCTF records offer unmistakable evidence pointing to widespread failures among construction employers to provide workers’ compensation insurance in accordance with state law. Between July 2016 and June 2020, a stunning 47.3% of approved WCTF cases (220 of 465) originated in the construction industry.¹¹⁸ In comparison, construction accounted for just 9.4% of workers’ compensation claims made through the coverage of law-abiding employers in the private sector between 2014 and 2016.¹¹⁹ The astounding gap highlights that the failure to maintain a valid workers’ compensation insurance policy is endemic in the Massachusetts construction industry, further reflecting the overall pervasiveness of wage and tax fraud in the sector.¹²⁰

Indirect Method: Misclassification by Trade

The DUA audits described earlier provided clear and direct evidence that worker misclassification is more extensive in some parts of construction than in others. But while this report used an indirect method to estimate the total number of workers affected by payroll fraud in the entire construction industry, data limitations make it practically impossible to use this approach to obtain exact numbers of workers affected by trade or narrowly-defined contractor type (e.g., framing, drywall).¹²¹ Fortunately, other data sources can be used to investigate these issues, each of which demonstrates alarming employment patterns in some trades and in some narrowlydefined contractor categories.

To identify the trades most affected by payroll fraud, Table 3 compares occupational employment estimates as computed through surveys of Massachusetts construction workers and surveys of legal construction employers in the Commonwealth. Similar to the indirect method offered earlier, the critical outcome is the size of the discrepancy between the two sources. The difference between the worker surveys (total employment) and employer surveys (legal wage-and-salary employment) is largely measuring “self-employment.”¹²² While this includes the legally self-employed, it also includes all misclassified independent contractors and off-the-books workers. Unusually large differences between worker and employer surveys is considered evidence of extensive wage and tax fraud is in that occupation.

Table 3. Comparing Occupational Employment in Worker Surveys and Employer Surveys, Massachusetts Construction Industry, 2016-19 (minimum 3,000 workers)

The results of Table 3 demonstrate that rates of “self-employment” are substantially higher in four trades—painters, roofers, laborers and carpenters—than elsewhere in the construction industry. While some of this may be due to differences in legal self-employment, the disparity in numbers from these four trades from the rest of the industry is stunning: the top four exhibit a self-employment rate exceeding 45% while the bottom four feature rates less than 20% (and two are in single digits). Given the magnitude of the disparity between the two groups, there is only one conclusion: payroll fraud is far more extensive among painters, roofers, laborers and carpenters than in other trades. This finding is further supported by the authors’ conversations with industry stakeholders, who have consistently pointed to these trades as the ones most troubled with wage and tax fraud concerns.¹²⁵

This approach is the best available statistical method of identifying potential payroll fraud by trade, however we suggest caution before explicitly citing the numbers presented in Table 3. First, the results do not offer direct evidence of illegality, as the results also reflect differences in legal self-employment across trades. Second, there are methodological concerns that introduce some margin of error into the analysis.¹²⁶ As one example, there are inconsistencies in how workers identify their occupations on surveys and how employers classify them. This is reflected in the bottom part of Table 3, as the negative rates for drywall installers and construction helpers are suggestive that, for example, many drywall installers in Massachusetts identify themselves as carpenters or laborers when asked on surveys to provide their occupation.¹²⁷ While methodological concerns may reduce the estimated discrepancy for carpenters and other trades, any decrease in magnitude would not be substantial enough to change the conclusion that the self-employment rate in these trades is alarmingly high and likely indicative of extensive worker misclassification.

Tax Records of Sole Proprietors

The conclusion that carpenters are among the trades most affected by payroll fraud is further supported by an analysis of 2019 tax data on sole proprietorships provided by the Massachusetts Department of Revenue.¹²⁸ Schedule C filings from personal income tax returns (Form 1) include employers’ expenses for “Contract Labor” (line 9B) and “Wages” (line 25); aggregating this data by industry code allows for a direct comparison of labor practices across different types of contractors.¹²⁹ This data is presented for 14 categories of specialty trades contractors in Massachusetts in Table 4.¹³⁰ The first four columns offer the number of firms by industry code, followed by the value of gross receipts, contract labor, and wages. The final column offers a simple and powerful metric: a ratio of expenditures on contract labor to expenditures on wages. It would be expected that sectors in which payroll fraud is most prevalent would have high levels of contract labor expenditures relative to wage-and-salary employment costs.

The results in Table 4 are astounding: the labor practices in some subsectors look fundamentally different than other parts of the state’s construction industry. For instance, framing contractors who are sole proprietors in Massachusetts paid a total of $9.03 million to contract laborers but just $4.77 million in wages in 2019; this equates to a ratio of 1.89, or the equivalent of $189 in contract work for every $100 paid to wage-and-salary employees. And framing contractors were not alone: among sole proprietorships, eight of 14 categories of specialty trades contractors paid more to contract laborers than wage-and-salary employees in 2019, including one sector—siding contractors—with an exorbitant rate of contract labor usage ($525 paid to contract labor for every $100 in wages).

These labor practices are profoundly different than those employed in other parts of the construction industry. For example, electrical contractors who are sole proprietors paid just $13 to contract laborers for every $100 distributed to wage-and-salary employees, or less than one-tenth the rate of contract work of framing contractors. The differences in contract labor usage by employer type are so pronounced that the results in Table 4 reflect a clear distinction between contractor types: those featuring “high” contract labor usage and those with “low” usage, with the latter appearing to rely more on traditional employment relationships.

Table 4. Analysis of Contract Labor and Wages, Sole Proprietorships (Schedule C), Specialty Trades Contractors (NAICS=238XXX), Massachusetts, 2019 ($ value in millions)

The results in Table 4 offer no direct proof of misclassification—hiring contract labor is not illegal on its face—and the data only cover sole proprietorships, which account for a fraction of most sub-sectors of construction (see Appendix C for more analysis of DOR tax data). But the reliance on contract labor in some subsectors is so substantial—and the distinction between high and low usage groups so stark— that the only reasonable conclusion is that wage and tax fraud is more extensive in these “high usage” categories. This inference is further supported by two important commonalities among this group. First, it cannot a coincidence that the contractors identified as most likely to be engaging in payroll fraud (Table 4) are also the ones that disproportionately employ tradespeople from the “big four” occupations identified earlier: painters, carpenters, roofers and laborers (Table 3).

Table 5. Comparison of Contract Labor/Wage Ratio of Sole Proprietorships (Massachusetts) to Proportion of Legal Wages Paid by Residential Contractors in the Industry (United States), 2019

Contractors featuring the most alarming employment patterns share a second important commonality. Table 5 pairs the contract-labor-to-wage ratio of Massachusetts sole proprietors with data from the Bureau of Labor Statistics that assesses the proportion of wages in each contractor category that are paid by residential contractors in the United States.¹³¹ The results, once again, are striking: contract labor usage is highest among contractors that predominantly operate in the residential sector. First, the three types of contractors with the highest rates of contract labor—siding, framing and finish carpentry contractors—are also the three types most likely to be operating in the residential sector. Further, the seven contractor types that conduct the largest proportions of their work in residential construction are all in the group that disproportionately relies on contract labor.¹³²

As further evidence that residential construction relies heavily on contract labor, Table 6 presents the aggregate 2019 tax records of sole proprietorships in the Massachusetts construction industry that are not specialty trades contractors. Any comparison of these firms is complicated by the fact that they may differ markedly in size, type of work, and general place in the contracting chain; in essence, it is difficult to compare the actions of a one-person homebuilding operation and that of a multi-million dollar company that builds highway bridges. Nevertheless, the reliance on contract labor among residential builders is striking, as the results of Table 6 demonstrate that residential construction firms pay $180 to contract laborers for every $100 paid to wage-and-salary workers. This is more than double the rate of nonresidential builders, and more than six times that of firms operating in the heavy and civil engineering sector of the construction industry. As a reminder, the reliance on contract laborers among residential builders offered in Table 6 is consistent with the findings of DUA audits (Table 2) that reflected widespread worker misclassification within that sector.

Table 6. Analysis of Contract Labor and Wages, Sole Proprietorships (Schedule C), Construction of Buildings (NAICS=2361XX and 2362XX) and Heavy and Civil Engineering Construction (NAICS=237XXX), Massachusetts, 2019 ($ value in millions)