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E Brief 20, August 2011 I L I M A F Informal and Nonstandard Employment G in the United States N I Implications for Low-Income Working Families K Demetra Smith Nightingale and Stephen A. Wandner R O

For many years, policy analysis on informal to a particular firm, not covered by employer- W employment primarily focused on less-developed sponsored benefits) to nonstandard or contingent economies. Informal workers are often concen- employment (such as temporary, intermittent, E trated in agricultural, domestic service, or manual part-time, day labor, and contract workers), which activities; they can include individuals who are may operate in the formal sector. In addition, M self-employed in the sense that they do not work individuals often mix formal, informal, and non- for any particular employer or firm. Whether standard work—for example, working a second O self-employed or working for others, individuals job or moonlighting, sometimes “off the books.”

C (and their employers) who do not report earnings This brief describes informal and nonstandard or income for tax purposes are part of the informal employment and explores the policy implications 1 Of the 9.7 million N economy. for low-skilled workers in those arrangements. I As capitalist economies mature and develop, Individuals in both informal and nonstandard uninsured parents in employment have relatively high poverty rates - regulatory and worker protection policies become the United States, as established, and social assistance expands, infor- and low earnings, and women represent a dispro- mal work should decline. Yet, today, informal portionate share of the workers. The poor, who many as 3.5 millionW work remains a major part of the economies of work mainly in the informal sector, may find it even more difficult than low-wage formal workers living below the O developed as well as developing countries. Some analysts suggest that the rate of informal work to raise themselves and their families out of poverty federal poverty levelL may be increasing partly in response to expanding through work alone because informal wages are could readily be globalization. New businesses are expanding in lower and there is less chance for wage increases.

N urban areas, but costs of starting up enterprises are made eligible for high, causing some entrepreneurs to operate in The Informal Market Medicaid under O the informal sector and pay lower wages to mini- and Public Policy mize expenses (Schneider 2002; Williams 2011). current law. S The literal definition for the informal sector Informal employment in the United States tends

E is straightforward: economic activities that are to be overlooked in policy circles. When it is outside tax and regulatory policies. This definition considered, it is often viewed in terms of black

V applies to both workers and the individuals or market (i.e., criminal and illegal) activities, I companies for which they work. In contrast, undocumented immigrants, or white-collar tax

T formal, or standard, employment generally refers evasion. Aside from these stereotypes, though, to regular wage and work arrangements at an informal employment represents various economic

C employer’s location or under the employer’s super- arrangements. The existence of the informal vision or policies, where the wages and income are market has implications for numerous policy E reported to the government as required by law. options related to workers and their families, and P In developed countries, including the United to businesses (particularly entrepreneurial activity

S States, the distinction between formal and infor- and small businesses). mal economic activities is not always clear. For For their informative book about how poor R example, informal employment is similar in some mothers live, Making Ends Meet, Edin and Lein E ways (e.g., operating without a regular attachment (1997) interviewed 349 low-income mothers; all P An Urban Institute Program to Assess Changing Social Policies

but one earned some income from informal work, provided in 2009 during the height of the reces- typically supplementing welfare payments or sion, also usually work through the formal system, earnings from formal low-wage jobs. Few of these providing special one-time payments to those who women were engaged in illegal activities such as file federal income tax returns. drug dealing or prostitution; the vast majority Welfare reform is also premised on formal indicated they “worked on the side,” regularly employment. Ideally, individuals move from pub- babysat, cleaned houses, did lawn and yard work, lic assistance to employment in the formal labor or collected cans and other recyclable items to market, and their wages are complemented by the earn money. In other words, the mothers per- EITC and tax credits to workers and employers. formed legitimate work outside the formal labor This expected pattern was confirmed during the market (that is, outside tax laws). economic boom of the 1990s, when the strong Public policies, though, strongly encourage demand for workers, along with changes in the formal employment. Workers benefit from par- nation’s welfare policies, contributed to substan- ticipating in the formal sector, as shown in the tial increases in employment among low-income left side of figure 1. American society, similar to parents, especially mothers. those of other developed economies, assumes that However, as Edin and Lein explain, informal, informal employment should be discouraged; it off-the-books work, which has always existed in also assumes that formal employment is at the the United States as in other countries, continued core of human capital development and is key to even during the booming 1990s. And informal achieving social welfare policy goals related to work has some positive aspects, as shown in the increasing individual economic self-sufficiency. right side of figure 1. The informal sector is a first Social insurance benefits are premised on work in entrée into work. Young people, for example, the formal sector, and the pathways to improved often babysit, mow lawns, and do other informal earnings and occupational upward mobility value work that provides them with income and intro- sustained formal work experience. Tax credits are duces them to the world of work and the respon- designed to encourage formal businesses and for- sibilities and expectations of that world. The mal work, and some key policy goals are achieved informal labor market has fewer barriers to entry through the income tax system. For example, than the formal market, and hours or work may the earned income tax credit (EITC) supple- be more flexible. Financially, workers who do not ments the income of workers who have earnings report their earnings avoid taxes, thus increasing from formal employment. Periodic economic their disposable income. And many adults who stimulus payments to individuals, such as those work more than one job at a time, either full

FIGURE 1. Benefits of Formal and Informal Employment for Workers

Formal Employment Informal Employment

Ⅵ Recognized work experience. Acquiring Ⅵ Tax avoidance. Earnings and payments work experience recognized in the labor not reported to the government. market that could lead to occupational Ⅵ Detection avoidance. With no reported mobility. earnings, one might avoid being detected Ⅵ Health insurance. Access to employer- and being required to fulfill other financial sponsored health insurance. responsibilities (e.g., debt repayment, Ⅵ Retirement. Accumulation of Social child support obligations). Security and other pension credits, along Ⅵ Flexibility. Increased possibility of arrang- with employer contributions. ing flexible hours of work; seasonal Ⅵ Unemployment insurance. Accumulation options. of necessary work history to qualify for Ⅵ Independence. Increased possibility of unemployment insurance. self-directed individual work arrange- Ⅵ Worker protections. Minimum wages, ment; creative endeavors. safe work conditions, workers compen- Ⅵ Ease of entry. No background checks or sation, antidiscrimination laws. references required; fewer education Ⅵ Tax credits. Qualification for employment- credentials needed. related tax credits and transfers (e.g., EITC).

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time or part time, view the informal sector as a A few examples highlight the definitional viable supplement to formal work. Some may complexities. combine formal and informal work, comple- menting regular pay with work done on the side. Ⅵ Self-employed entrepreneurs. Many international Thus, formal employment reinforces some reports of the informal sector likely include important national policy goals, such as improving black-market and illegal activity as well as working conditions and compensation, creating jobs, small-scale personal service or production, and strengthening the formal economy. It also rein- which might also be referred to as self- forces the social value of work and self-sufficiency. employment. In the United States, entrepre- neurs who do not report their income are considered informal (or illegal) workers; How Is Informal Work Defined? those who do pay taxes may be considered There is no clear consensus across nations on nonstandard workers if they have an arrange- what constitutes informal employment. At the ment with an employer and both report their most basic level, informal employment means compensation, or they may be considered employment that occurs outside the tax and small businesses if they report business income regulatory systems. Informal employment is for tax purposes. understood to include “all remunerative work— Ⅵ Manufacturing production. Activities related to both self-employment and wage employment— manufacturing and dealing counterfeit manu- that is not recognized, regulated, or protected by factured items and electronic material, which existing legal or regulatory frameworks and non- are illegal (at least under U.S. law), involve remunerative work undertaken in an income- otherwise legitimate labor activities (production, producing enterprise,” including people who work assembly, marketing, sales, etc.). An analyst through subcontracting arrangements made by or might have to decide whether workers in such entered into by employment agents activities are to be considered in the informal (International Labour Office 2002, 11). That is, (but legitimate) sector or in the illegitimate the term informal employment typically incorpo- sector not generally considered part of the rates all economic activities that operate outside informal sector. government rules, taxes, regulations, and moni- Ⅵ Bartering. Individuals at all skill levels may trade toring (Feige 1977; Hart 1973). Portes (1981), or barter their skills, services, or production for example, defines informal employment as with others. At higher ends of the economic work performed in income-producing endeavors scale, professionals may make informal pay- that operate without formal wage arrangements. ment arrangements for services and may not Moving beyond this general definition, the include such compensation in their account- concept becomes more complex. In the broadest ing for tax purposes. sense, informal employment includes both legiti- Ⅵ Undocumented immigrants. Some workers at mate (not criminal) activities for which one all income levels may be performing legitimate receives payment, such as babysitting or construc- activities, but their work is outside the tax and tion work, and illegitimate or criminal activities, regulatory system because the individuals are such as drug dealing, smuggling, prostitution, not legally authorized to work in the United human trafficking, or dealing stolen goods. In States. Some perform the same work alongside terms of social acceptability, few argue that such legal, and therefore formal, workers. black-market criminal activities should be charac- terized as legitimate economic activity. The dis- Figure 2 categorizes the various complex cussion of informal employment below excludes arrangements workers may have in the formal such criminal endeavors. and informal sectors, excluding those engaged in Other labor arrangements that violate laws criminal activities. The shaded area represents only because they occur outside the tax and regu- arrangements that include informal employ- latory system are viewed differently than criminal ment. On the far right side of the figure are activity. The term “shadow economy,” for exam- undocumented immigrants who are not legally ple, often refers to actions individuals take to authorized to work. Many of them, of course, evade taxes or compliance with labor and wage do work, but they are all working informally regulations in otherwise legitimate activities or in since they cannot legitimately participate in the illegal activities (Fleming, Roman, and Farrell tax or regulatory system. All other workers 2000). Work in the informal economy is also can work in the formal sector, but not all do. often defined differently depending on the stage Moving from right to left, some workers work of economic development in a particular country. only in the informal sector, some mix formal

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FIGURE 2. Range of Informal and Formal Employment Options for Workers

Undocumented or not Type of worker: Documented or authorized to work authorized to work

Nature of work: Formal work only Ⅵ Standard arrangement (regular employee) Some formal work and Ⅵ Nonstandard arrangement Informal work only Informal work only some informal work (e.g., contingent, on-call, part-time, temporary, contractor)

Type of work: Formal Informal (within tax and regulations) (outside tax and regulations)

and informal work, and some work only in the yet been fully put into practice, several surveys formal labor market. have recently adopted some ICLS concepts. The formal and informal sectors overlap, and The ILO has synthesized the results of surveys in delineation by worker or nature of the job is not 70 developing and 30 developed countries (table 1). always possible. Not all workers are exclusively It concludes that there is more informal employ- either in the formal sector or in the informal ment in developing countries, such as Southeast sector. And, an employment arrangement is Asia and sub-Saharan Africa, than in developed informal if either the worker or the employer fails countries, and that most informal work in all coun- to report earnings; in other words, the worker tries represents what is commonly referred to as does not always determine whether he or she self-employment. In developing economies, the works informally or formally. ILO notes that “informal employment (outside of agriculture) represents nearly half or more of total How Much Informal Employment non-agricultural employment” (ILO 2002, 17). Is There?

Given the lack of uniformity in the definition of TABLE 1. Approximate Share of the Economy informal work and problems with measurement, and the Labor Force That Is Informal, it is not surprising that it is also difficult to know Selected Countries, Mid-1990s the extent of informal economic activity in the United States and in other countries. Informal Informal % employment is not captured by official govern- of GDP ment statistics and reports because individuals and employers involved in the informal sector are not Greece, Italy, Portugal, 20–30% likely to report all economic activity (Kalleberg Spain et al. 1997). Estimating the size of the informal Germany, Great Britain, 10–18% economic sector is difficult, and cross-national esti- Ireland mates are particularly challenging if one attempts Latin America 25–60% to distinguish between licit and illicit activities. Asia 15–50% To analyze the informal sector, the Inter- Africa 30–60% national Conference of Labor Statisticians (ICLS), United States 5–10% a consortium of statisticians under the aegis of Informal % of the International Labour Organization (ILO), labor force adopted an international definition in an effort to reconcile competing definitions and create a Italy 30–48% consistent framework for statistical analysis. This Spain 11–32% definition of the informal economic sector Germany 12–22% includes “all unregistered or unincorporated France 3–12% enterprises” (ILO 2002, 11) below a certain United States 3–40% threshold determined by national circumstances and regulations. Although the definition has not Sources: ILO (2002); Gunn (2004); Schneider (2002).

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The size of the informal sector in developed Informal employment exists at all socioeconomic countries is more uncertain. For example, reviews levels but is concentrated among the poor. Most suggest a very large range of estimated informal informal and nonstandard employment is concen- employment in the United States, from 3 to trated in the lower end of the workforce. Especially 40 percent of the total workforce (Gunn 2004). in developed countries, however, it also includes Using 12 different categories of nonstandard some middle-class or professional workers. work and Bureau of Labor Statistics data, Polivka Current policies provide both incentives and and Sorrentino (2008) estimate nonstandard work- disincentives to participating in formal employment. ers represented between 11 and 20 percent of all Welfare policies under TANF are built around a U.S. workers in the late 1990s and early 2000s. number of financial incentive formulas designed Some research also suggests that nonstandard to make work pay more than welfare. Work in work has increased significantly in the United the welfare sense means work in the formal sector. States beginning in the 1980s because of a grow- And, many work-related benefits accrue to work- ing immigrant population reliant on nonstandard ers through the formal sector. Income tax credits, work, usually informal arrangements (Tanzi 1999), like the EITC, require that individuals formally and an increasingly decentralized labor movement report income (i.e., engage in the formal economy). (Houseman and Osawa 2003). Low-income workers without children and The scale of informal economic activity in those not eligible for TANF (e.g., those who have monetary terms is even harder to estimate. Despite reached their welfare time limit and noncustodial a body of literature linking informal and non- parents) have fewer incentives to work formally, standard work with a prospering and even vibrant and in fact may have more disincentives to engage underground economy (de Soto 1989; Thomas in the formal economy. Some may choose not to 1992) and research indicating a trend among file if they learn or suspect that they will “owe the middle-class Americans to pursue contingent labor IRS.” Contract workers and other casual employ- as a supplement to standard work (Mattera 1985), ees, for example, who would be required to file in reality, informal and nonstandard work is con- income taxes as self-employed would be subject to centrated at the lower end of the wage scale and self-employment taxes (such as the employer’s share represents a disproportionate share of female, black, of FICA) even if their earnings are so low they and Hispanic workers (Horowitz 2000, 394). would not owe income taxes; not reporting income means avoiding the tax. Noncustodial parents who are delinquent in their child support payments risk Policy Implications and Options having their formal wages garnished; working This brief review of concepts and definitions informally avoids this risk. helps clarify the complexity of issues related to Tax credits are also available to businesses for informal employment. A few general points can hiring welfare recipients or other targeted popula- be summarized. tions if the firm follows federal wage, hour, and tax The distinction between formal and informal policies (i.e., operates in the formal economy). But work, and standard and nonstandard work, is some employers may choose to operate informally ambiguous. The distinctions may be particularly because the costs of formalizing are considered too ambiguous in developed countries, like the high (such as paying Social Security taxes for house- United States, because more workers may com- hold workers). Others may use nonstandard work bine informal and formal employment. Any arrangements to avoid some expenses associated examination of the informal sector, therefore, with regular employees (e.g., health, vacation, and requires also examining the formal sector, paying other benefits). particular attention to the interaction between the two and between informal employment and Policy Options That Could Improve nonstandard employment. Some individuals the Economic Well-Being work in both the formal and informal sectors. of Low-Income Workers Estimates of the scale of informal employment are incomplete, but the United States has at least Low-income families that depend mainly on infor- several million informal workers. There are no pre- mal and nonstandard work are likely to find it diffi- cise estimates of the size of the informal employ- cult to improve their economic status. A few policy ment sector in the United States, but it could changes could shift some informal and nonstan- range from 3 to 40 percent of the total non- dard workers to formal, standard arrangements. agricultural workforce, depending on how infor- mal is defined. Even at the low end, that means Ⅵ Increase informal workers’ access to occupa- there are nearly 4 million informal workers. tional skills training. Informal employment is

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frequently periodic, part time, low wage, and Ⅵ Encourage firms and employers to use low skilled. Workforce development programs standard rather than nonstandard work and staff should be better informed about arrangements by revising how the IRS informal workers and take steps to reach those classifies low-paid workers as independent workers, provide them with labor market contractors and self-employed; revisions information, and help them access and pay for would provide incentives for some firms occupational training. Skills training could that now hire contract or temporary help low-skilled workers qualify for better jobs workers to convert them into standard but often requires them to reduce their wage and salary employees (Bassi and employment while participating. McMurrer 1997, 57–59). Business tax Ⅵ Expand child care support for low-income credits for employers who convert non- part-time working parents. Many voluntary standard workers to standard workers part-time workers, particularly mothers, could might be one option. be helped to move to full-time work with more subsidized child care and an improved supply In summary, some policy changes could of appropriate child care (e.g., for infants, change the incentives and disincentives and facil- before/after school, summer). Provision of itate a shift from the informal to the formal sector child care could make it easier for workers in and from nonstandard to standard work arrange- the informal sector and those in nonstandard ments. In doing so, more workers could benefit work to move into regular, full-time formal from worker security and tax incentive policies employment. initially designed primarily for formal employ- Ⅵ Modify some immigrant worker provisions ment. And more self-employed workers now to acknowledge their role in the economy. outside the tax system (and therefore informal) Immigration reform could bring more immi- could be brought into the formal sector. grants into the formal sector. If immigration provisions are modified to allow more individ- uals currently working informally to move into Note a status that eventually allows them to work legally in the United States, some portion may 1. Many analysts speak about the “informal sector” or of move to formal standard employment. ‘informal jobs,” and the discussions can be from the per- spective of employers or of workers (Lee, McCann, and Ⅵ Establish policies that would reduce or Messenger 2007). In this brief, our unit of analysis is eliminate delinquent child support pay- workers or jobs rather than employers. ments for low-income individuals who make regular current payments for a given period. Allowances should be made for those References who become involuntarily unemployed. Ⅵ Change some tax provisions to encourage Bassi, Laurie J., and Daniel P. McMurrer. 1997. “Coverage formal employment. Individuals formalize if and Recipiency.” In Unemployment Insurance in the they file income tax returns. United States: Analysis of Policy Issues, edited by Ⅵ Expand the EITC to offset the payroll Christopher J. O’Leary and Stephen A. Wandner tax for lower-income workers. This (51–90). Kalamazoo, MI: W. E. Upjohn Institute for change would reverse the disincentives Employment Research. that exist for some workers, particularly de Soto, Hernando. 1989. The Other Path: The Invisible those without dependent children, and Revolution in the Third World. New York: Harper & Row. would have the added benefit of increas- ing the individual’s countable Social Edin, Kathryn, and Laura Lein. 1997. Making Ends Meet: Security quarters. How Single Mothers Survive Welfare and Low-Wage Work. New York: Russell Sage Foundation. Ⅵ Encourage more informal workers to report as self-employed by a) increasing the self- Feige, Edgar L. 1977. “The Anatomy of the Underground employment tax deduction for low-income Economy.” In The Unofficial Economy, edited by Sergio filers to encourage more contract and Alessandrini and Bruno Dallago. Aldershot, UK: Gower. informal workers to file income tax returns as self-employed; and b) expanding the Fleming, Matthew H., John Roman, and Graham Ferrell. unemployment insurance program’s cover- 2000. “The Shadow Economy.” Journal of International Affairs 53(2): 387–409. age to include the self-employed or provide them with unemployment assistance under Gunn, Christopher. 2004. Third-Sector Development: Making certain circumstances if they pay taxes. Up for the Market. Ithaca, NY: Cornell University Press.

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Hart, Keith. 1973. “Informal Income Opportunities and University Workshop on Measuring Informal Employment Urban Employment in Ghana.” Journal of Modern African in Developed Countries, October 31–November 1. Studies 11(1): 61–89. Portes, Alejandro. 1981. “Unequal Exchange and the Urban Horowitz, Sara. 2000. “New Thinking on Worker Groups’ Informal Sector.” In Labor, Class, and the International Role in a Flexible Economy.” In Nonstandard Work: The System, by Alejandro Portes and John Walton. New York: Nature and Challenges of Changing Employment Academic Press. Arrangements, edited by Françoise Carré, Marianne A. Ferber, Lonnie Golden, and Stephen A. Herzenberg Schneider, Friedrich 2002. “Size and Measurement of the (393–98). Champaign, IL: Industrial Relations Research Informal Economy in 110 Countries around the World,” Association. Paper presented at the workshop of the Australian National Tax Centre, Australian National University, Canberra, July. Houseman, Susan, and Machiko Osawa. 2003. “The Growth of Nonstandard Employment in Japan and the United Tanzi, Vito. 1999. “Uses and Abuses of Estimates of the States: A Comparison of Causes.” In Nonstandard Work in Underground Economy.” Economic Journal: The Journal Developed Economies: Causes and Consequences, edited by of the Royal Economic Society 109(456): F338–47. Susan Houseman and Machiko Osawa (175–214). Thomas, J. J. 1992. Informal Economic Activity. London: Kalamazoo, MI: W. E. Upjohn Institute for Employment Harvester Wheatsheaf Press. Research. Williams, Colin C. 2011. “Formal and Informal Employment International Labour Office. 2002. Women and Men in the in Europe: Beyond Dualistic Representations.” Paper pre- Informal Economy: A Statistical Picture. Geneva: sented at the European Union Conference on Informal/ International Labour Organization. Undeclared Work, Brussels, May 21, 2003. Kalleberg, Arne L., Edith Rasell, Naomi Cassirer, Barbara F. Reskin, Ken Hudson, David Webster, Eileen Appelbaum, About the Authors and Roberta M. Spalter-Roth. 1997. Nonstandard Work, Substandard Jobs: Flexible Work Arrangements in the U.S. Demetra Smith Nightingale is a senior fellow Washington, DC: Economic Policy Institute. in the Urban Institute’s Center for Labor, Human Services, and Population. Her research concen- Lee, Sangheon, Deirdre McCann, and Jon C. Messenger. trates on employment, skills training, social assis- 2007. Working Time around the World: Trends in Working Hours, Laws, and Policies in a Global Comparative tance, women and family issues, immigration, Perspective. Geneva and London: International Labour youth development, and welfare reform. Organization and Routledge. Stephen A. Wandner is a visiting fellow in Mattera, Philip. 1985. Off the Books: The Rise of the the Center for Labor, Human Services, and Underground Economy. New York: St. Martin’s Press. Population. A former senior economist at the Polivka, Anne, and Connie Sorrentino. 2008. “Measuring Non- U.S. Department of Labor (DOL), he has Standard and Informal Employment in the United States directed DOL research on unemployment insur- Using Bureau of Labor Statistics Data.” Paper prepared for ance, dislocated worker employment services, WIEGO, Kennedy School of Government, Harvard and job training programs.

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This brief is part of the Urban Institute’s Low-Income Working Families project, a multiyear effort that focuses on the private- and public-sector contexts for families’ success or failure. Both contexts offer opportunities for better helping families meet their needs.

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THE URBAN INSTITUTE 2100 M Street, NW Washington, DC 20037 The views expressed are those of the authors and do not necessarily reflect those of Copyright © 2011 the Urban Institute, its boards, its sponsors, or other authors in the series. Permission Phone: 202-833-7200 is granted for reproduction of this document with attribution to the Urban Institute. Fax: 202-467-5775 Melissa Hinton, an MPP candidate at Johns Hopkins University, contributed importantly E-mail: [email protected] to this brief.