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Data Analysis
Employee Misclassification Investigations
The most direct evidence of payroll fraud in Rhode Island comes from investigations by the Wage and Hour Division of the Department of Labor and Training in the pursuit of cases against employers suspected of violating state labor law. Table 1 highlights that between 2019 and 2021, DLT investigators charged 180 companies with engaging in worker misclassification that directly affected 740 workers. A substantial majority of these cases— roughly 70%—were within the construction industry. These investigations—which included nearly 100 cases in 2021 alone—establish that worker misclassification is a significant problem in Rhode Island.
Table 1. Results of Employee Misclassification Investigations, 2019-21
| Year Investigation Closed | Total Companies in Violation | Construction as % of Total Companies | Total Employees Misclassified | Construction as % of Total Employees |
|---|---|---|---|---|
| 2019 | 37 | 41% | 132 | 58% |
| 2020 | 55 | 76% | 318 | 64% |
| 2021 | 88 | 84% | 290 | 78% |
| Total | 180 | 73% | 740 | 68% |
That the construction industry accounts for a disproportionate number of worker misclassification cases in Rhode Island is consistent with trends in other states. Misclassification in construction is problematic for reasons beyond its prevalence and the number of workers affected. Across the country, construction employers found to be violating labor law are notorious for their ability to evade responsibility for their illegal actions. In the face of a significant penalty, it is commonplace in the industry for the principal of a construction employer to close their current business and open a new one with a different name simply to avoid legal action. In many other cases, the violator is an out-ofstate contractor who evades responsibility simply by leaving the state or jurisdiction in question (a problem that is especially acute in a small state like Rhode Island). Considering that construction firms are far more likely than those in other industries to be small and mobile (e.g., not bound to a storefront), it allows these businesses greater ability to avoid legal action.
Consistent with this national story, the results of Table 2 reflect construction employers’ increased likelihood of evading regulatory action for their illegal labor practices. In Rhode Island, employers who are determined by DLT investigators to be misclassifying are assessed a fine equal to full and complete back pay for workers and a dollar-for-dollar punitive penalty to be collected by the state. The results reflect that the DLT assessed $1.2 million in fines in the 180 cases concluding between 2019 and 2021, with approximately 70% ($832,000) coming from cases from the construction sector. But construction employers found responsible for violating labor law in Rhode Island pay far less of their assessed fines (35%) than employers outside of construction (56%). This nonpayment represents an evasion of justice that has real consequences and real victims: the aggrieved workers who never receive back pay to make them whole after the exploitative and illegal actions of their employer.
Table 2. Penalties Assessed and Collected through Employee Misclassification Investigations, 2019-21
| Year Investigation Closed | Penalties Assessed | Penalties Collected | % Penalties Collected |
|---|---|---|---|
| ALL INDUSTRIES | |||
| 2019 | $225,500 | $97,450 | 43% |
| 2020 | $494,500 | $211,750 | 43% |
| 2021 | $475,000 | $186,975 | 39% |
| Total | $1,195,000 | $496,175 | 42% |
| CONSTRUCTION | |||
| 2019 | $139,500 | $39,250 | 28% |
| 2020 | $320,500 | $106,750 | 33% |
| 2021 | $372,000 | $145,350 | 39% |
| Total | $832,000 | $291,350 | 35% |
| NON-CONSTRUCTION | |||
| 2019 | $86,000 | $58,200 | 68% |
| 2020 | $174,000 | $105,000 | 60% |
| 2021 | $103,000 | $41,625 | 40% |
| Total | $363,000 | $204,825 | 56% |
Stop Work Orders
Employers who misclassify workers are likely to engage in other forms of payroll fraud. This includes the failure to secure a workers’ compensation insurance policy, which is required by law of any business with employees. This problem is especially acute in the construction industry, and the failure of contractors to maintain an active workers’ compensation insurance policy exposes their workers to significant risk of financial peril—medical costs and a loss of income due to an inability to work—given the high rate of workplace accidents in construction settings.
This risk put upon uninsured workers is a large part of why many states have the ability to issue a Stop Work Order (SWO). This typically prohibits continuance of work at a site until employers have an active workers’ compensation insurance policy in compliance with state law. In Rhode Island, this process is overseen by the Workers’ Compensation Division of the Department of Labor and Training. As provided in Table 3, the DLT issued 589 SWOs across all industries between 2016 and 2020.11 While the DLT notes that many employers come into compliance relatively quickly, the Workers’ Compensation Division assesses penalties for periods where insurance was required but not in place. Between 2016 and 2020, this amounted to $754,561 assessed by either employer agreements with the DLT or through the Workers’ Compensation Court.
Table 3. Stop Work Orders Issued and Penalties Assessed, 2016-20
| Year | Stop Work Orders Issued | Total Penalties Assessed | Penalties: Payment Agreement w/DLT | Penalties: Workers’ Compensation Court |
|---|---|---|---|---|
| 2016 | 144 | $119,256 | $23,410 | $95,846 |
| 2017 | 148 | $360,176 | $59,802 | $300,373 |
| 2018 | 142 | $119,865 | $25,204 | $94,662 |
| 2019 | 114 | $119,163 | $42,435 | $76,727 |
| 2020 | 41 | $36,102 | $8,554 | $27,548 |
| Total | 589 | $754,561 | $159,405 | $595,156 |
Unemployment Insurance Audits
The most expansive evidence of payroll fraud in the United States comes from state agencies’ audits of employer payroll records. In the operation of state unemployment insurance (UI) programs, the U.S. Department of Labor requires state officials to audit employers’ records to ensure that workers are correctly classified, that all wages and salaries are reported to the government, and that all relevant taxes are paid by the employer (specifically contributions to state UI programs). In the study of payroll fraud in the U.S., reviews of state UI audits represent the predominant approach in documenting worker misclassification. Studies conducted by academic scholars and state agencies alike have commonly used audit results to document extensive illegality in workplaces across the country.12
In Rhode Island, UI audits are conducted by the Department of Labor and Training. For this study, the DLT provided audit results of employer payrolls between 2016 and 2021. The data were anonymized and the authors had no information that allowed them to identify specific employers or workers involved. Across this six-year period, the DLT completed 3,470 UI payroll audits, including 432 on construction employers. Audits typically review four quarters of a business’s payroll records, but the time period can be expanded if the audit uncovers an employee that is misclassified; especially egregious cases are shared with the Division of Taxation, and to other divisions within the DLT (e.g., Division of Labor Standards). Most UI audits are conducted on firms selected at random among employers in the state’s UI system. However the DLT supplements these with targeted audits on firms where there is evidence that a business may be actively engaged in misclassification.13
The overall results of UI audits completed in Rhode Island by the DLT between 2016 and 2021 are presented in Table 4. On random audits—which encompasses the best available cross-section of employers in this study for making statewide projections—approximately one in five employers (20.3%) underreport wages on required payroll forms submitted to the state as a part of its unemployment insurance program. Many instances of underreporting are small as roughly half (48%) of such cases feature less than $10,000 underreported, however approximately 10% of employers who are found to underreport wages do so with at least $100,000 in wages and salaries. Altogether, the results of random audits reflect that Rhode Island employers underreport 0.8% of wages to the DLT, which extrapolates to $185.3 million in unreported wages based on 2019 labor market data.14,15
Table 4. Unemployment Insurance (UI) Payroll Audits, All Industry and Construction Totals, 2016-2021
| All Industries | Construction | |||
|---|---|---|---|---|
| Random Audits | All Audits | Random Audits | All Audits | |
| AUDIT RESULTS (2016-21) | ||||
| Number of Payroll Audits | 3,226 | 3,470 | 384 | 432 |
| % of Employers Misclassifying: Wages (Employers who underreport total wages) | 20.3% | 23.2% | 27.3% | 32.9% |
| % of Wages Underreported | 0.8% | 1.3% | 2.4% | 3.8% |
| % of Employers Misclassifying: Employees (Employers who underreport # of employees) | 9.3% | 12.2% | 11.7% | 17.1% |
| % of Industry Workforce Misclassified | 4.4% | 7.3% | 8.4% | 16.1% |
| STATEWIDE ESTIMATES (2019) | ||||
| Total Wages Underreported (in $ millions) | $185.3 | $290.2 | $31.1 | $49.6 |
| Total Number of Workers Misclassified | 19,359 | 33,469 | 1,828 | 3,843 |
Unsurprisingly, firms who illegally misclassified employees as independent contractors are far more likely to be identified as underreporting significant amounts of wages and salaries in their filings with the government. And the results from Table 4 indicate that employee misclassification is rampant in Rhode Island, with 9.3% of random audits identifying employers who were misclassifying at least one employee. Across all industries, the data reflects that 4.4% of the Rhode Island workforce is misclassified; using 2019 data, this equates to 19,359 workers in the state.16
There are several reasons to suspect that the totals offered via random audits in Table 4 are substantially undercounting the extent of misclassification in Rhode Island. Employers engaging in illegal labor practices will often go to great lengths to conceal their actions from government regulators and tax agencies.17 This includes, but limited to, an increased reliance on cash-only employment relationships that have come to define the “underground economy.” Construction stakeholders in the state and across the country that have been interviewed by the authors overwhelmingly suggest that the industry is awash in cash-only employment relationships. But this type of employment often lacks any type of paper trail, making it difficult, if not impossible, for even the most-skilled investigators to prove every instance of illegal misclassification; this also makes audits of cash-based businesses (e.g., nail salons, cleaning companies, construction) especially challenging.18
The results of random audits are also likely to undercount the degree of payroll fraud in Rhode Island because they are likely to exclude the most prolific violators of labor law. By definition, UI audits are restricted to employers who are registered within the state’s unemployment insurance system. However, a recent report in Massachusetts highlighted the emergence and influence of “labor brokers” in the New England construction sector that operate entirely off the books and who pay their workers in cash; none of these employers would appear in the UI database and, accordingly, would never directly be subject to a UI audit.19
While imperfect, one commonly-used approach to account for the undercounting of misclassification on random audits is to examine the aggregated results of all UI audits, both random and targeted, as the latter is more likely to identify employers engaged in illegal labor practices. This “all audit” total for Rhode Island is provided in the second column of Table 4. The results suggest that 23.2% of employers in this combined sample were found to be misclassifying by underreporting wages amounting to 1.3% of wages and salaries. The results also reflect that 12.2% of employers misclassified workers, representing 7.3% of the state’s workforce. Further, the all-audit total suggests that Rhode Island employers may have underreported up to $290.2 million in wages in 2019 and misclassified 33,469 employees as independent contractors (which includes paying workers off-the-books).20
Even with omission of labor brokers and some cash-only payments, the last two columns of Table 4 nevertheless highlight that misclassification is rampant in the Rhode Island construction industry as measured via UI audits. Rates of wage underreporting and employee misclassification are far higher in construction than the state average. Using both totals as endpoints, the results of Table 4 reflect that 27.3% (random audits) to 32.9% (all audits) of construction employers underreported wages while between 11.7% and 17.1% of businesses misclassified employees as independent contractors. These actions affect a substantial number of workers, as the results reflect that between 1,828 (8.4% of the industry) and 3,843 (16.1%) construction workers were denied their rights under state labor law due to illegal misclassification. Meanwhile, wage underreporting allowed construction employers to evade required taxes and social contributions on between $31.1 and $49.6 million in wages.
Two perspectives emerge in a comparison of the data provided in Table 4 to other sources. First, worker misclassification has gotten worse in Rhode Island over the last 10-15 years. A 2009 report submitted to the Rhode Island General Assembly suggested that UI audits of the time reflected that 6% of employers were found to misclassify at least one employee; the results above reflect that 9.3% to 12.2% of employers were doing so in 2016-2021.21 Second, a statistical approach applied by the authors in previous studies suggests that the construction-specific totals expressed in Table 4—even the “all audit” totals—are likely to be undercounting the full extent of payroll fraud in the state’s construction industry.22
Expanding the analysis, Table 5 presents an industry-by-industry comparison of UI audit results that reflects misclassification to be especially prevalent in a few key sectors of the Rhode Island economy. Three industries appear especially troubling: construction (16.1% of workers misclassified across all audits), administrative and waste management services (21.9%; includes janitorial and landscaping services), and other services (13.1%; includes automotive repair, nail salons, dry-cleaners, parking garages).23 While misclassification rates are much lower for these industries when limiting the sample to randomly-selected employers, these three industry categories clearly reflect the highest rates of employee misclassification and wage underreporting. In reviewing the underlying data, the construction industry and the administrative and waste management services industries are especially concerning in that they feature both (a) the highest proportions of employers engaged in any form of misclassification and (b) the highest rates of employers who engaged in extensive misclassification (i.e., those with more misclassified workers than regular employees).24
Table 5. Misclassification Rates, Major Industry Totals (min. 100 audits), 2016- 2021
| Industry | Number of Audits | % of Employers Underreporting Wages | % of Industry Wages Underreported | % of Employers Misclassify Workers | % of Industry Workforce Misclassified |
|---|---|---|---|---|---|
| ALL AUDITS | |||||
| Administrative & Waste Mgt. Services | 239 | 34.7% | 3.0% | 20.5% | 21.9% |
| Construction | 432 | 32.9% | 3.8% | 17.1% | 16.1% |
| Other Services (except Public Admin.) | 342 | 23.1% | 2.5% | 11.1% | 13.1% |
| Wholesale Trade | 138 | 21.0% | 0.8% | 14.5% | 4.8% |
| Accommodation & Food Service | 453 | 22.1% | 0.8% | 11.9% | 4.6% |
| Manufacturing | 247 | 22.3% | 0.4% | 11.3% | 3.3% |
| Retail Trade | 403 | 18.4% | 1.0% | 7.7% | 2.5% |
| Professional, Scient. & Tech. Services | 387 | 16.8% | 0.6% | 6.2% | 2.5% |
| Health Care & Social Assistance | 365 | 23.0% | 0.6% | 12.1% | 2.2% |
| Total (includes excluded groups) | 3,470 | 23.2% | 1.3% | 12.2% | 7.3% |
| RANDOM AUDITS ONLY | |||||
| Administrative & Waste Mgt. Services | 216 | 31.5% | 2.7% | 16.7% | 16.4% |
| Construction | 384 | 27.3% | 2.4% | 11.7% | 8.4% |
| Other Services (except Public Admin.) | 318 | 21.1% | 1.7% | 8.8% | 7.7% |
| Wholesale Trade | 132 | 19.7% | 0.9% | 12.9% | 5.1% |
| Manufacturing | 235 | 20.9% | 0.4% | 11.1% | 3.4% |
| Accommodation & Food Service | 402 | 19.9% | 0.5% | 9.0% | 2.4% |
| Health Care & Social Assistance | 351 | 21.1% | 0.5% | 10.3% | 1.9% |
| Retail Trade | 384 | 16.1% | 0.5% | 5.2% | 1.1% |
| Professional, Scient. & Tech. Services | 373 | 14.2% | 0.3% | 3.8% | 0.7% |
| Total (includes excluded groups) | 3,226 | 20.3% | 0.8% | 9.3% | 4.4% |
To this point, a focus of this report has been examining conditions within broad industry totals. But the use of overall industry totals may conceal as much as they reveal. For example, the construction industry is comprised of markedly different sub-sectors based on trade and building type. Conditions in each sub-sector vary markedly on the basis of occupational licensing and worker skill requirements, union involvement, wage and benefit levels, and most important to this study, the extent of worker misclassification, wage theft, and other forms of payroll fraud. Therefore, any policy action designed to reduce illegal labor practices in the construction sector must first recognize the specific sub-sectors where misclassification is most prevalent.
To those ends, Table 6 provides a summary look at audit results within the four largest subsectors of the Rhode Island construction sector (as defined by a four-digit industry code). The results reflect that the extent of misclassification is distinctly different within various subsectors of the Rhode Island construction industry. Most glaringly, illegal labor practices appear particularly rampant among residential builders, a result consistent with prior research on the New England construction industry.25 Combining the values from the random and all-audit totals, the results of UI audits reflect that one in three residential builders underreports wages to the DLT, aggregating to approximately 7%-13% of all industry wages and salaries. This is the second-highest wage underreporting rate of any sub-industry in Rhode Island (min. 20 audits), just slightly behind general freight trucking. The results also reflect that residential builders misclassify 31%-48% of their employees. While this may include a lot of short-term workers, it represents the second-worst rate of any sub-sector in Rhode Island behind general freight trucking (all audits) and services to buildings and dwellings (random audits), which includes janitorial and landscaping.
Table 6. Results of UI Employer Payroll Audits, Subsectors of Construction Industry (min. 60 audits), 2016-2021
| Residential Building (NAICS=2361) | Foundation, Structure & Exterior (NAICS=2381) | Building Equipment (NAICS=2382) | Building Finishing (NAICS=2383) | |
|---|---|---|---|---|
| ALL AUDITS | ||||
| Number of Payroll Audits | 87 | 62 | 118 | 83 |
| % of Employers Underreporting Wages | 36.8% | 32.3% | 23.7% | 41.0% |
| % of Wages Underreported | 12.7% | 3.1% | 2.3% | 7.9% |
| % of Employers Misclassifying Workers | 23.0% | 8.1% | 13.6% | 26.5% |
| % of Industry Workforce Misclassified | 47.5% | 3.9% | 8.3% | 24.2% |
| RANDOM AUDITS | ||||
| Number of Payroll Audits | 75 | 56 | 110 | 67 |
| % of Employers Underreporting Wages | 29.3% | 28.6% | 20.0% | 34.3% |
| % of Wages Underreported | 7.1% | 2.9% | 1.3% | 5.1% |
| % of Employers Misclassifying Workers | 14.7% | 3.6% | 10.9% | 17.9% |
| % of Industry Workforce Misclassified | 31.3% | 1.8% | 4.7% | 12.4% |
Among the remaining three categories of specialty trades contractors, misclassification also appears quite prevalent among the building finishing trades which include drywall, painting, flooring, and finish carpentry. More than one-third of these contractors underreport wages to the DLT, amounting to 5%-8% of all wages and salaries in the category; this is the fourth-worst rate of any sub-sector in Rhode Island that featured at least 20 audits. Further, the audits reflect that 12%-24% of the sub-sector’s workforce is misclassified as independent contractors or paid off-the-books, which is approximately three times the statewide average across all industries.
As evidence that labor conditions vary distinctly within the Rhode Island construction industry, the other two subsectors of construction summarized in Table 6 feature much lower rates of worker misclassification. Among foundation, structure and building finishing contractors (which includes masons, structural steel, concrete foundations, framing and roofing), wage and worker misclassification rates as reflected in UI audits were far below the overall state average. For building equipment contractors (electrical, plumbing, HVAC), the results were close to state averages but far below rates in other subsectors of the state’s construction industry. It is telling that this pattern of misclassification—egregiously high among residential builders and building finishing contractors but much lower in the other two categories—is consistent with a similar review of UI audits in Massachusetts between 2017 and 2019.26
There is value examining the results in specific trades. However, this is problematic given that there are not a sufficient number of UI audits in many narrowly-defined industry categories to draw justifiable conclusions. But among those narrower classifications (fivedigit industry codes) with at least 20 UI audits completed by the DLT, the results presented in Table 7 offer some powerful perspectives. First, residential builders exhibit the highest employee misclassification rate (47.5%) in the all-audit total and the second-highest rate (31.3%) among firms that are audited at random. Second, painting contractors and finish carpentry contractors—each included in the “building finishing” category in the earlier analysis—each reflect worker misclassification rates in the all-audit total that places them in the top five in the state; neither had the minimum of 20 random audits to quality for the bottom half of the panel.
Table 7. Highest Worker Misclassification Rates, Five-Digit NAICS Industry Totals (min. 20 audits), 2016-2021
| Industry | Number of Audits | % of Employers Underreport Wages | % of Employers Misclassify Workers | % of Workers Misclassified |
|---|---|---|---|---|
| ALL AUDITS (31 industries) | ||||
| Residential Building Construction | 87 | 36.8% | 23.0% | 47.5% |
| Janitorial Services | 36 | 55.6% | 38.9% | 45.8% |
| Painting & Wall Covering Contractors | 20 | 40.0% | 25.0% | 35.7% |
| Landscaping Services | 118 | 33.9% | 22.9% | 33.8% |
| Finish Carpentry Contractors | 21 | 38.1% | 23.8% | 26.8% |
| RANDOM AUDITS ONLY (26 industries) | ||||
| Janitorial Services | 29 | 51.7% | 31.0% | 42.2% |
| Residential Building Construction | 75 | 29.3% | 14.7% | 31.3% |
| Landscaping Services | 111 | 31.5% | 19.8% | 28.9% |
| Wholesale Trade Agents/Brokers | 20 | 30.0% | 15.0% | 20.9% |
| Offices of Real Estate Agents/Brokers | 33 | 15.2% | 6.1% | 15.0% |
Beyond the construction industry, the results of Table 7 reflect that two types of businesses—janitorial and landscaping—exhibit misclassification rates that far exceed anywhere else in the non-construction economy. Even among randomly-selected (i.e., non-targeted) firms that provide janitorial services, greater than 40% of employees are deemed by the DLT to be misclassified. Landscapers also reflect substantial rates of misclassification with roughly one-third of workers not correctly identified as employees. Given that both business types are included in the “administrative and waste management services” industry that was prominent in earlier tables, it is clear that these two business types are largely responsible for the elevated rates within that sector.
Direct Costs of Misclassification
The intentional misclassification of employees as independent contractors—or paying workers entirely off-the-books—is typically rooted in the desire by employers to avoid paying taxes and required social contributions as a means of improving their own profits. These illegal and unethical labor practices come at an enormous cost to workers and their families, law-abiding employers, and Rhode Island taxpayers.27 Most directly, workers who are misclassified as independent contractors are denied their legal rights to overtime pay, unemployment insurance benefits, investments into their Social Security accounts, certain OSHA protections, workers’ compensation insurance benefits, and protection under the Family and Medical Leave Act and other laws that only provide rights and benefits to employees. This puts Rhode Island workers in a highly precarious position, exposing them to both physical and financial risk on a daily basis. As a result, it is far too common to hear stories of construction workers left in physical ruin while dealing with soul-crushing medical bills after a workplace injury made possible by their employer’s indifference to safety and failure to provide worker’s compensation insurance benefits.28
While misclassified workers often bear the largest burden of employers’ illegal labor practices, other parts of Rhode Island society must also absorb the effects of this corrosive behavior. Law-abiding businesses have difficulty competing with companies that illegally reduce labor costs far beyond what the legitimate market would support, resulting in a “race to the bottom” in heavily affected sectors such as residential construction. Rhode Island taxpayers are also affected. Most directly, millions of dollars in payroll are never reported to the state government, resulting in substantial income tax losses. The state’s unemployment insurance, temporary disability insurance, and job development funds all experience a revenue shortfall as employers evade required payments in the system. At the federal level, Social Security exhibits a substantial revenue shortfall due to persistent misclassification.29 And with employers either bypassing workers’ compensation insurance or doing so fraudulently, this raises insurance premiums on law-abiding businesses.
Estimating the cost of worker misclassification on taxpayers is complicated by the fact that the highest-quality data on the problem—UI audits—undercount the volume of wages paid off-the-books and the number of workers affected. Nevertheless, cost projections using this data represent an important lower-bound of the direct costs of misclassification on Rhode Island taxpayers. Using the estimated amount of wage underreporting in the state economy in 2019 (identified earlier in this report), the results in Table 8 suggest that worker misclassification allowed Rhode Island businesses to illegally reduce their labor costs between $27.0 million and $41.9 million. Most directly to workers, estimates in Table 9 reflect the workers lost $2.1 million and $3.2 million in overtime pay (i.e., the “half” in time-and-a-half), projections that are likely to undercount the true costs to workers by a substantial margin due to methodological reasons.30
Table 8. Estimated Costs of Worker Misclassification, All Industries, Based on Estimated Proportion of Wage Underreporting on UI Audits, 2019
| All Industries |
|---|
| Random Audits | All Audits |
|---|
| STATEWIDE ESTIMATES | ||
| Total Wages Misclassified | $185,270,354 | $290,164,438 |
| COST OF PAYROLL FRAUD | ||
| Unemployment Insurance Fund Shortfall | $6,984,392 | $10,546,719 |
| Temporary Disability Insurance Fund Shortfall | $2,037,974 | $3,191,809 |
| Job Development Fund Shortfall | $389,068 | $609,345 |
| Unpaid Workers’ Comp. Insurance Premiums | $1,352,474 | $2,118,200 |
| Employer Share of FICA Offloaded onto Workers | $14,173,182 | $22,197,580 |
| Overtime and Premium Pay Not Received | $2,056,927 | $3,221,493 |
| Total Reduced Employer Cost | $26,994,017 | $41,885,146 |
| TAX REVENUE | |||
|---|---|---|---|
| State Income Tax Shortfall | Low | $2,223,244 | $3,481,973 |
| High | $4,446,488 | $6,963,947 | |
|
Total State Revenue Lost (UI + TDI + JDF + State Income Tax) |
Low | $11,634,678 | $17,829,846 |
| High | $13,857,923 | $21,311,820 |
Beyond the direct impacts to workers, the totals suggest that Rhode Island taxpayers were directly affected, as the loss to state revenue was between $11.6 million and $21.3 million. Of this total, $7.0 million to $10.5 million were revenue shortfalls from the Rhode Island unemployment insurance program, $1.4 million to $2.1 million lost from the temporary disability insurance fund, and around half a million dollars in uncollected money for the job development fund.31 At the federal level, Rhode Island employers offloaded between $14.2 million and $22.2 million in required Social Security payments onto the backs of workers. In effect, being treated as independent contractors instead of employees means that workers must pay both the employee and employer share of Social Security. Finally, misclassification led to between $1.4 million and $2.1 million in unpaid workers’ compensation insurance premiums, another value that is likely to substantially understate the extent of the problem due to limitations with the data.32
Worker misclassification also affects state income tax revenues, albeit in an indirect way. For regular employees who receive a W-2, employers are legally required to report their payroll totals to tax agencies and deduct state income taxes from workers’ paychecks. But for independent contractors, the responsibility of reporting and paying taxes on that income falls entirely on the shoulders of the workers themselves. While estimates vary, research has predictably demonstrated that a substantial proportion of income earned outside of a formal employment relationship is not reported on tax forms. Combining a low and a high estimated rate of income underreporting with the lowest marginal tax rate in Rhode Island (3.75% in 2019), Table 8 presents projections suggesting that worker misclassification in the state led to a revenue shortfall between $2.2 million and $7.0 million.33,34
It is reminded that the projections in Table 8 represent a lower-bound estimate of the cost impact of worker misclassification on Rhode Island taxpayers as these are based on the hard evidence made available in UI audits about the amount of wages unreported to the DLT. But, as discussed earlier, UI audits do not represent a complete census of misclassification and many instances are either undetectable on audits, nearly impossible to prove, or are occurring through unregistered or out-of-state employers. As a result, any attempt to estimate the costs associated with the full extent of worker misclassification must rely on assumptions about the number of workers and volume of wages involved in these illegal labor practices. The use of assumptions to project economic costs is standard practice among researchers when faced with incomplete information, however doing so injects an unavoidable degree of margin of error into the estimates. The approach used in this report has been used often on similar studies in other states and is nearly identical to the method used by research staff at the Rhode Island Workers’ Compensation Court in an analysis included in a 2009 report to the General Assembly.35
To offer an estimate of the potential cost effect of worker misclassification in Rhode Island, the analysis requires two key assumptions. First, as a means of building a conservative projection in the face of incomplete information, the authors assume that UI audits represent an accurate count of the number of workers affected by misclassification (19,359 via random audits; 33,469 via all audits). Second, the authors assume that each of these workers earned $27,400 in 2019. This represents the median annual income of self-employed, unincorporated Rhode Island workers in the 2019 American Community Survey (the closest category to misclassified workers in the survey), and the use of this assumed value is consistent with occupational earnings data available from the Bureau of Labor Statistics.36
Table 9 presents the projected costs of worker misclassification using these assumptions. Predictably, the presumption that misclassified workers earn more money than is identified on UI audits leads to much larger estimates of the economic costs associated with employee misclassification. The topline numbers of this assumption-based approach suggests that employers were able to shave between $69.1 million and $119.4 million in labor costs by misclassifying workers in 2019, headlined by the fact that workers directly lose an estimated $5.9 million to $10.2 million in legally-earned overtime pay. With regard to lost state tax revenue, the model projects that worker misclassification cost Rhode Island taxpayers between $25.1 million and $54.4 million in 2019, with at least $11 million coming from losses from the state’s UI fund.37
Table 9. Estimated Costs of Worker Misclassification, All Industries, Based on Assumptions of the Number of Workers and Wages Misclassified, 2019
| All Industries |
|---|
| Random Audits | All Audits |
|---|
| STARTING ASSUMPTIONS | ||
| Number of Workers Affected (from UI audits) | 19,359 | 33,469 |
| Annual Earnings (from American Community Survey) | $27,400 | $27,400 |
| Total Wages Misclassified | $530,431,779 | $917,062,634 |
| COST OF PAYROLL FRAUD | ||
| Unemployment Insurance Fund Shortfall | $11,904,709 | $20,582,032 |
| Temporary Disability Insurance Fund Shortfall | $5,834,750 | $10,087,689 |
| Job Development Fund Shortfall | $1,000,077 | $1,729,031 |
| Unpaid Workers’ Comp. Insurance Premiums | $3,872,152 | $6,694,557 |
| Employer Share of FICA Offloaded onto Workers | $40,578,031 | $70,155,292 |
| Overtime and Premium Pay Not Received | $5,889,013 | $10,181,504 |
| Total Reduced Employer Cost | $69,078,731 | $119,430,105 |
| TAX REVENUE | |||
|---|---|---|---|
| State Income Tax Shortfall | Low | $6,365,181 | $11,004,752 |
| High | $12,730,363 | $22,009,503 | |
|
Total State Revenue Lost (UI + TDI + JDF + State Income Tax) |
Low | $25,104,717 | $43,403,503 |
| High | $31,469,898 | $54,408,255 |
The topline state revenue numbers in the “all audit” total in Table 9 ($43.4-$54.4 million) are consistent with similar findings by the Workers’ Compensation Court which, in 2009, used a similar assumption-based approach to suggest that misclassification cost the state $49.9 million in uncollected taxes and contributions.38 However, had the authors in the current study used the less conservative assumptions applied by the Workers’ Compensation Court in 2009—that misclassified workers earn state-average wages—the results of the analysis in Table 9 would have reflected lost tax revenues totaling between $66.4 million and $89.3 million in 2019.39
While Tables 8 and 9 represent efforts to measure the direct costs to Rhode Island taxpayers that result from misclassification, it is important to highlight that these estimates reflect only a small portion of the costs borne by the state. In addition to these direct costs, there are countless indirect costs that are exacerbated by the precarious employment situations of affected workers. This includes an increased need for income-supporting social programs, greater reliance on the government-funded health insurance, greater psychological strain on workers and their families, higher workers’ compensation insurance premiums for law-abiding firms, and a host of other concerns.
Finally, it is recognized that these projections ignore a particularly damaging form of payroll fraud: explicit wage theft. There are countless examples of employers simply refusing to pay workers what they are owed, from recent court cases in Rhode Island to numerous studies documenting its presence in the New England construction industry.40 However, there are no quantitative records on wage theft that are sufficient for the authors to project its extent or costs to workers on an aggregate basis in the state of Rhode Island.