April 21, 1994, Thursday, Final Edition
HEADLINE: The Real Nannygate Scandal
BYLINE: Barry Nalebuff, Eric Muller
The latest chapter in "Nannygate" -- featuring White House lawyer William H. Kennedy III -- occurred close enough to April 15 to point up one of the less publicized features of this seemingly unending series of revelations about public officials and their domestic help: its undeniable connection to income tax evasion.
The Kennedy case, like its predecessors, focused on the consequences of not paying Social Security taxes and on the domestic worker's resulting loss of retirement income. But what about the income taxes? If the Nannygate scandal is worthy of its historic suffix, it is not because of missed Social Security payments. That's the tail wagging the dog. The real problem is that too often the income often goes unreported, so that neither income nor Social Security taxes get paid. There would be no scandal as long as those hired, as self-employed individuals, paid Social Security and income taxes themselves. Problems only arise when nobody --neither employer nor employee -- reports the income and pays the taxes.
Which raises the question: Why haven't any of the casualties of Nannygate simply cleared the air by pointing to their employees' returns? Perhaps because the income was never reported and income taxes never paid.
When the income isn't reported, who gets the benefits? It's not just the employee. Because the income was unreported, the employer has a safeguard that ensures the employee will never expose or even later claim the missed Social Security payments. Moreover, the wages are adjusted to reflect the expectation that taxes are not going to be paid. Paying in cash can raise the effective wage by almost 40 percent!
Take as the baseline case a couple with one dependent child where only one person works, earning $15,000, all of it reported. In 1993, this family would get an earned income tax credit of $1,060. If the other spouse now takes a job as household help and earns $15,000 under the table, the family income goes up to $31,060. If these additional wages were reported, they would have to amount to $20,750 to bring the family's after-tax income to the same level. The employer thus can save $5,750 by keeping the transactions off the books.
Most of that gain goes to the employer, not the employee. People who get paid in cash work for a lot less money. The irony is that it's the employee who risks the big penalty by not reporting income (the employer gets only a fine and a slap on the wrist for failing to make Social Security payments) and yet the real beneficiary is the employer.
Congress seems to want to obviate the need to comply with tax laws by raising the reporting threshold. The House's budget bill was passed last year with a provision (later dropped) raising the threshold reporting level for requiring Social Security payments to $1,800. The Senate is considering a similar measure that would also exempt domestic help under 18.
There is a better solution to this problem. The simplest IRS form to fill out is a 1099. It can be done in 10 minutes. A 1099 is required only for persons engaged in a trade or business and making payment in the course of such trade or business in excess of $600 a year. Since a homeowner is not in the business of living in his or her home, no 1099 is at present needed for payment to domestic help. But why not expand the requirements to include domestic workers? Once the income is reported (and once the worker knows the income will be reported) you can rest assured (or lie awake afraid) that Uncle Sam will get both the Social Security and income taxes owed and that workers will get paid in a way the reflects the cost of these taxes.
Barry Nalebuff is a professor of economics and Eric Muller a master's candidate at the Yale School of Management.