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Cash economy threatens wages, tax base
By Beth Barrett Staff Writer
Published: Monday, May 6, 2002 in the Los Angeles Daily News

Los Angeles County's underground cash economy has exploded, jeopardizing public services and new investment and leaving hundreds of thousands of workers without a safety net, according to new economic data and research.

A new study co-authored by Daniel Flaming, president of the Economic Roundtable, a nonprofit, public policy research organization in Los Angeles, estimates that up to 1.5 million of Los Angeles County's workers are now paid in cash — a destabilizing economic trend that runs counter to the rest of California and the country.

The study, supported by data compiled by Los Angeles Mayor James Hahn's economic development team and other experts, has led researchers to estimate about $1.1 billion a year, in violation of the law, is not being paid into Social Security, workers' compensation, health insurance and other social safety net programs to protect workers who become ill, injured or unemployed, or who retire.

The researchers also said low-income employees in the county's underground economy stand to lose an additional $1.5 billion a year by forgoing the federal tax credits for which they otherwise would be eligible.

Up to 28 percent of the work force in the county is paid in cash, meaning as many as one in four don't have federal and state payroll taxes withheld, which creates the kind of economic unpredictability that potential employers tend to avoid, Flaming said.

"One problem in Los Angeles is the huge changing environment when you want to convince the rest of the world you're a coherent environment, that the rules are understandable, and that behavior is predictable. If you're in a shadow economy that's not regulated, it's profoundly incoherent."

Companies, he said, don't want to put "money down a rathole."

And workers who receive low wages and no benefits are limited in their spending power, which reduces retail sales and the resulting sales tax revenue.

And employers who cheat by not making Social Security and other payments gain an unfair competitive advantage over those who comply with the law.

"This is the low road of economic growth," Flaming said in an interview.

"It is not law-abiding, and it is not in good faith. It is an extremely meager course of economic development and provides bleak chances of upward mobility."

Mayor James Hahn said he is disturbed by the growing underground economy and said it must be reversed through enforcement, training programs and creation of "real jobs," to prevent an undermining of society and an erosion of the local tax base.

"It's about having a society where you're not creating this permanent underclass," Hahn said. "In the long term we have to see what we can do to invest in human capital. We have to help (workers) into jobs that have some dignity.

"In the meantime, we have to continue to go out there and find people breaking the law and bust them."

Hahn said the city would continue to assist the state, which has the primary enforcement responsibility, to crack down on employers who evade payroll taxes, while insisting city contractors adhere to the law.

Valley economic leaders were shocked by the results of the study, saying it suggested the informal economy is at least double the conventional thinking on its size.

"That astounds me it could be that high," said Bruck Ackerman, president of the Economic Alliance of the San Fernando Valley. "I never heard more than 10 to 15 percent. Wow."

Ackerman said he was unaware of studies specifically examining the cash-based economy of the Valley.

"It hasn't hit our radar, but that doesn't mean it doesn't exist."

Jack Kyser, chief economist at the private, nonprofit Los Angeles County Economic Development Corp., said the study is consistent with its research, saying untaxed sales from corner street vendors alone are estimated at about $250 million annually.

"We'd estimate the underground economy would be very, very significant," Kyser said. `'It represents a huge entrepreneurial (economy), but lots of tax revenue is being lost by local government at a time when they need all they can get."

Labor leaders agreed.

"I've seen (the informal economy) in statistics and in real life," said Julie Butcher, general manager of Service Employees International Local 347.

Butcher said so many workers who "are not even on the chart" creates an economy with "spiral to the bottom," where the gap between rich and poor widens, and the middle class looses ground.

"It's not like middle-class folks are doing better, middle-class people are falling," Butcher said.

Butcher said the informal economy is largely impervious to the help unions historically have provided labor.

"It's hard to organize someone who for all formal appearances doesn't exist," Butcher added.

Flaming said it's incumbent on politicians and policy makers to come to grips with the depth of the informal economy and to devise "serious, competent public strategies," not retrench to rhetoric and boosterism.

"Life is not served on a plate to us. Sunshine and beaches is not enough," he said.

Joy Chen, the mayor's director of economic recovery, said the problem of the burgeoning cash economy has been identified at the top levels of the city and that there are efforts under way to better track it and to reverse the trend.

Chen said the problem is compounded by L.A.'s education profile, where 24 percent of working-age people have less than a high school diploma compared with 15 percent for the country; and 11 percent in the city have less than a sixth-grade education, compared with 3 percent nationwide.

"We're worse than any major metro area, including New York," Chen said, referring to data compiled by her office. "We're worse off than Mobile, Alabama. Clearly something is going on in Los Angeles. It's an issue that concerns everyone."

Hardest hit are the neighborhoods of the inner city where the recession, 1992 riots, and other factors today mean there are seven residents per job, a rate almost twice that of East L.A., and the North San Fernando Valley, and more than four times that of West Los Angeles.

Flaming and Pascale Joassart-Marcelli evaluated hundreds of thousands of employment records, including welfare-to-work, and federal and state payroll documents, correcting for self-employment, and multiple jobs, and other factors in arriving at the scope of the informal economy.

Their work suggested L.A.'s "informal," or cash-based, economy where payroll transactions are hidden "under the table" and "off the books" has grown far beyond street corners where day laborers wait for work and is now flourishing in major commercial sectors.

"Employers of informal labor appear to be most frequently in a variety of manufacturing industries (paper, lumber and wood, metal, glass and concrete, food and tobacco, textile and apparel, plastics), as well as agriculture, construction, private household services, miscellaneous retail and restaurants," their research concludes.

There are indications, for example, that as much as 20 percent of the janitorial work in the county is done on a cash-only basis.

Mike Garcia, president of SEIU Local 1877, said the percentage would be far higher, or up to 80 percent, without the successful strikes and subsequent unionization of many of the janitorial businesses that service the prominent business in downtown.

"It's still common among all the little contractors, the mom and pops that open one day and close the next, and service strip malls, small offices," Garcia said.

"Without the union, janitors are easy prey, because it's low skill and they work at night," in addition to language and cultural differences that make them more vulnerable to exploitation, he said.

"They are the urban farm workers," Garcia added.

Those exploiting the "informal economy" — distinguished from the black market in that illegal goods are not being sold — have taken advantage of Southern California's relatively slow recovery from the recession of the early 1990s at the same time the labor market was being flooded with hundreds of thousands of immigrants willing to work for low wages, many of them undocumented.

"For many of them, life has never been better, but their benchmark is a village in Mexico or in El Salvador," Flaming said. The benchmark for L.A. has been far different, as the formal economy that runs under the law has grown weaker.

"The (formal) economy has been so stagnant that there are fewer wage and salary jobs than in 1990," Flaming said, even as the number of working-age adults went up 6 percent during the decade.

Nowhere has the combination of economic forces been felt more strongly than among middle-class wage earners who held many of the blue-collar manufacturing jobs — like those in aerospace and the auto industry, in companies that have left the region.

"There has been a hollowing out of the middle in Los Angeles, a decline in the number of jobs in the midrange of the salary scale," Flaming said.

Chen in the Mayor's Office and local economists say major changes are needed to alter how the work force operates if Los Angeles is to remain competitive.

"The solution will take a concerted partnership with business, employers, the Los Angeles Unified School District, community colleges, universities and community-based organizations," Chen said.

While Chen called it unrealistic to expect government alone to change the trajectory of a region's development, she said available resources can make a difference.

"We're looking to focus on growing industries with a high number of entry-level jobs that pay good wages and have strong career ladders," Chen added, citing health care as an example.

And Flaming said it is imperative to raise the profile of workers who are now invisible in the cash economy by better enforcing labor regulations.

The Internal Revenue Service and state Franchise Tax Board have aggressive education programs on payroll laws to augment criminal investigation efforts.

Still, Franchise Tax Board spokesman Patrick Hill said the state estimates a $3 billion tax loss annually, due in large part to the underground economy.

IRS spokeswoman Deborah Guajardo in Los Angeles said the agency is steadily making inroads into the underground economy through programs that match various kinds of financial records, and other methods.

"It's getting more and more difficult to live in the underground economy," Guajardo said, adding the agency hasn't done studies specifically targeting the L.A. area. "It's a crime, and we do take it seriously."

Kyser, the economist, said the problem is compounded because so many immigrants come from countries that deal primarily in cash and where distrust of the government is high.

"It's going to be hard. These are people completely under the radar of all government entities," Kyser said, noting that cottage businesses can operate out of homes or garages.

"You'd have to investigate almost every structure in the community," Kyser said. "It would take time. You'd have to put on a happy face and say, we won't hurt you, but please come out of the cold."

The study suggests some remedies, including more labor organizing of employees working off payroll, or even giving amnesty to longtime workers. It urges education in English and other employment-enhancing skills.

"We have been very negligent in our human capital," Flaming said. "We need to give people tools to advance above the survival level."