Level the Playing Field: Put California’s Underground Economy Out of Business REPORT #226, MARCH 2015 LITTLE HOOVER COMMISSION DEDICATED TO PROMOTING ECONOMY AND EFFICIENCY IN CALIFORNIA STATE GOVERNMENT Little Hoover Commission Pedro Nava† To Promote Economy and Efficiency Chairman Loren Kaye* The Little Hoover Commission, formally known as the Milton Vice Chairman Marks “Little Hoover” Commission on California State Government Organization and Economy, is an independent state oversight agency. Katcho Achadjian Assemblymember By statute, the Commission is a bipartisan board composed of five David Beier public members appointed by the governor, four public members Anthony Cannella appointed by the Legislature, two senators and two assemblymembers. Senator In creating the Commission in 1962, the Legislature declared its p urpose: Jack Flanigan Don Perata ...to secure assistance for the Governor and itself in promoting economy, efficiency and improved services in the transaction of the public business Sebastian Ridley-Thomas Assemblymember in the various departments, agencies and instrumentalities of the executive branch of the state government, and in making the operation of all state Richard Roth Senator departments, agencies and instrumentalities, and all expenditures of public funds, more directly responsive to the wishes of the people as David A. Schwarz expressed by their elected representatives... Jonathan Shapiro The Commission fulfills this charge by listening to the public, Sumi Sousa consulting with the experts and conferring with the wise. In the course *Served on subcommittee of its investigations, the Commission typically empanels advisory †Served as subcommittee chair committees, conducts public hearings and visits government operations in action. Former Commissioners Who Served During the Study Its conclusions are submitted to the Governor and the Legislature for Anthony Rendon their consideration. Recommendations often take the form of legislation, Assemblymember which the Commission supports through the legislative process. Commission Staff Carole D’Elia Executive Director Contacting the Commission Jim Wasserman All correspondence should be addressed to the Commission Office: Deputy Executive Director Little Hoover Commission Krystal Beckham Project Manager 925 L Street, Suite 805, Sacramento, CA 95814 Sherry McAlister (916) 445-2125 Associate Governmental [email protected] Program Analyst This report is available from the Commission’s website at www.lhc.ca.gov. Jasraj Singh Sangha Intern State of California LITTLE HOOVER COMMISSION March 9, 2015 The Honorable Edmund G. Brown Jr. Pedro Nava Governor of California Chairman Loren Kaye The Honorable Kevin de León The Honorable Bob Huff Vice Chairman President pro Tempore of the Senate Senate Minority Leader Katcho Achadjian Assemblymember and members of the Senate David Beier The Honorable Toni G. Atkins The Honorable Kristin Olsen Anthony Cannella Speaker of the Assembly Assembly Minority Leader Senator and members of the Assembly Jack Flanigan Don Perata Dear Governor and Members of the Legislature: Sebastian Ridley-Thomas Assemblymember Richard Roth During the past year, the Commission heard from more than 150 concerned Senator Californians about the challenges of the insidious multi-billion dollar underground David Schwarz economy. Long-time business owners told us how hard it is to stay afloat as Jonathan Shapiro competitors undercut bids to gain an unfair advantage by ignoring laws and licensing Sumi Sousa rules. California workers told stories of being harassed and demoted for filing unfair Carole D’Elia wage claims against unscrupulous bosses. These lawbreakers misclassify, shortchange Executive Director and do not adequately insure their employees and pocket payroll and sales taxes that should be paid to the state. Non-compliance by some California businesses hurts everyone as the impacts ripple outward: honest business owners, employees, the neighborhood, the state. State estimates suggest losses of $8.5 billion or more annually in uncollected tax revenue. Putting an end to cheating is one of those issues where business and labor agree and can rally together to bring about solutions. In this study, the Little Hoover Commission provides 15 recommendations to help level the playing field for California businesses and protect workers by reducing the scale of the underground economy. The recommendations fall into three broad categories: 1) enforcement, 2) accountability and 3) education. Enforcement. The Commission found the underground economy is growing and thriving in part because of insufficient resources for enforcement. The Commission learned that many cheaters break the rules because getting caught is unlikely. If they are caught, few are charged in court. When found guilty, the profits from cheating often outweigh the fines and penalties. More, there is an abysmal record of collecting restitution, as the cheaters hide assets to avoid paying anything at all and quickly set up shop again under new ownership. Unfortunately, for some, cheating is business as usual. The Commission found laws can be so confusing and inconsistent that even business owners who try to comply sometimes later learn they have broken rules. Recommended improvements include defining independent contractor in statute, bolstering asset seizure laws, and generally refining laws to improve clarity and to ensure rewards don’t outweigh risks. The Commission also recommends replicating the current workers’ compensation fraud grant funding model to other high-fraud areas, enabling local district attorneys to increase their role in tackling the underground economy. Milton Marks Commission on California State Government Organization and Economy http://www.lhc.ca.gov/ 925 L Street, Suite 805 Sacramento, CA 95814 916-445-2125 fax 916-322-7709 e-mail [email protected] The state should make it easier for agencies to do their jobs by expanding and improving information sharing – while ensuring privacy is adequately protected. And it recommends the state evaluate its investigator and audit and compliance civil service classifications for consistency. Accountability. The Commission found that although numerous government organizations focus on tackling the underground economy, no one is directly in charge. Hardworking government employees do their best to combat the problem, but often without adequate resources or the data or equipment to effectively do their jobs. There are four major state task forces focused on the underground economy, but it is not clear, overall, what the outcomes have been. The Commission recommends the Governor appoint a temporary independent leader, in consultation with state leaders who have jurisdiction over the underground economy, with clear authority to untangle any overlaps in responsibilities, bridge silos and move efficiently toward results. This leader should report back in six months on administrative or legislative changes needed to overcome the obstacles. Government also must lead by example. The Commission recommends that government entities award contracts to the lowest “responsible” bidder to avoid hiring businesses that may be breaking laws to provide the lowest bid. Education. Education, outreach and simply making it easier to comply should be the first priority of government. The Commission calls for a three-pronged statewide educational strategy that teaches consumers, public employees and businesses and workers about the harmful effects of the underground economy and how to avoid participating in it. To make it easier for businesses to comply, the Commission recommends a one-stop information shop on how to legally own and operate a business and a master business application that would allow business owners to interact with various state government entities through one portal. Finally, it recommends expanding opportunities for voluntary audit programs and working with industry associations to create self-certification programs. Taking more aggressive action against the underground economy is essentially about fairness. Business owners should know the state stands with them against cheating competitors. Workers should know they stand a chance against employers who misclassify them or short their checks. Taxpayers should expect they will not pay more because some businesses don’t pay at all. The Commission maintains that an economy based on fairness will go far in assuring California’s continued success. It respectfully submits these findings and stands ready to help you take on this challenge. Sincerely, Pedro Nava Chairman LEVEL THE PLAYING FIELD: PUT CALIFORNIA’S UNDERGROUND ECONOMY OUT OF BUSINESS Table of Contents Executive Summary…………………………………………………………………………………….. i The Underground Economy in California………………………………………………….……… 1 Leadership Void Creates Incentive to Cheat……………………………………………………… 17 Improving Tools for Enforcement…………………………………………………………………… 37 Preventing the Underground Economy……………………………………………………………. 51 Conclusion……………………………………………………………………………………………...... 73 The Commission’s Study Process……………………………………………………………………. 77 Appendices & Notes.…………………………………………………………………………………... 81 Appendix A: Public Hearing Witnesses………………………………………..…………………….................. 83 Appendix B: Advisory Committee Meeting Participants…………………………………………................ 85 Appendix C: The Commission’s 1985 Recommendations……………………………………………………... 89 Appendix D: Case Study: Heating, Ventilation and Air Conditioning Unit Replacements…………….. 91 Appendix