California officials vow to crack down on underground economy

Reporting from Sacramento — 

A burgeoning underground economy is costing California about $7 billion annually in lost tax revenue and undercutting companies that play by the rules.

That has state officials vowing to crack down on employers who pay their workers cash under the table to avoid payroll taxes, workers’ compensation insurance and other government mandates.

Agencies including the Employment Development Department and the Contractors State Licensing Board increasingly are coordinating efforts to target suspected scofflaws.

The Department of Industrial Relations is also ratcheting up efforts to find cheats, Acting Director Christine Baker said at a hearing in Sacramento this week. Computerized searches are helping the agency flag companies that file some tax and insurance documents but fail to submit other required reports.

A recent review of records from nearly 1,500 employers revealed that nearly a third lacked legally required workers’ compensation insurance coverage to pay the medical bills of employees hurt on the job, Baker said.

Many of those workers seek treatment at hospital emergency rooms, a burden that ultimately falls on insured patients and taxpayers. They also seek benefits from state workers’ compensation courts and money that comes from a special state fund that passes the costs along to law-abiding employers. Off-the-books laborers likewise don’t pay income taxes, while their employers avoid payroll taxes to fund unemployment insurance benefits.

Bottom line: Tax-paying companies, consumers and taxpayers are stuck paying the bill for cheats.

“If everybody paid their fair share, all of us would see a reduction of 25% in our taxes,” said Dan Kurttila, chief of compliance at the California Employment Development Department, who also spoke at the hearing.

California’s underground economy has been growing for years, but concerns have been heightened by the economic downturn. Cash-strapped consumers and businesses increasingly have been turning to shadow operators for lower-cost roofing, cleaning, warehousing and other services.

But falling tax revenue means larger deficits for governments struggling to provide public services. And it’s making it tough for legal businesses to compete.

Sacramento electrical contractor Mark Cooper said his workforce has fallen to 31 employees from a peak of 390 in 2005. Most of that reduction is due to the housing bust. But Cooper said he’s now being undercut by freelance electricians who don’t pay taxes or carry insurance. He estimated that he could triple his workforce if the playing field were leveled.

“There’s no whistles, there’s no flags, there’s no penalties,” he said. “Those of us playing by the rules do question why we have to play by the rules.”

Unfair competition is compelling more contractors, even licensed ones, to take shortcuts to compete, according to David Fogt, enforcement chief for the California Contractors State Licensing Board.

A recent survey of 305,000 licensed California contractors showed that nearly two-thirds had filed papers with the board claiming that they should be exempt from carrying workers’ compensation insurance because they had no employees. Experts said it’s unusual for so many licensed contractors to have no workers on their payrolls; more likely, they said, many of those contractors are illegally misclassifying the status of their employees to avoid carrying workers’ comp insurance.

State law requires that all employers carry such coverage, which is particularly important in construction, where workers are more likely to suffer injuries. In one dangerous trade, roofing, a new law mandates that small-company owners have workers’ compensation insurance even if they have no direct employees.

Tax and insurance cheating is rampant in the construction, janitorial, courier, landscaping and food service fields, officials said, where cheaper shadow operators are winning business from legitimate firms.

Low-ball contracts are common in the commercial janitorial business, said Pete Conaty, an industry lobbyist in Sacramento.

“If someone walks in [to a big chain store] and says, ‘I’ll clean all your stores for 70% of what you currently are paying,’ the chain says, ‘That sounds good; let’s sign a new contract,’” Conaty said.

Small-business owners support tough enforcement as long as it’s aimed at the worst offenders and doesn’t devolve into “gotcha” raids that harass companies for small infractions, said Scott Hauge, founder and chairman of Small Business California, a statewide advocacy group.

A survey showed that 44% of the group’s members identified the underground economy as a major competitive problem.

“When I talk to small businesses, they are outraged because they see their taxes are higher because people aren’t playing by the rules,” Hauge said.

A variety of state agencies are coordinating efforts to target suspected underground economy employers and issue more citations.

In October and November, the state Department of Labor Standards Enforcement levied more than $1 million in fines against two labor subcontractors — Premier Warehousing Ventures and Impact Logistics Inc. — for failing to maintain employee time records and for failing to provide itemized wage statements to employees. The subcontractors provided workers to a Riverside County warehouse owned by Schneider Logistics, which distributes goods for Wal-Mart Stores Inc.

Many small and medium-size business owners say they can’t afford to wait too long for state action to level the playing field.

“I’ll be happy if I’m here next year still in business,” said Kevin Burns, a landscaper from South San Francisco. “Without enforcement it’s like the wild, wild West. There won’t be any legitimate contractors left to regulate.”

marc.lifsher@latimes.com