What Is the Underground Economy and How Does It Affect You?
Investigation looks as the impact of unreported, non-taxed business and how it affects the pallet industry.
By DeAnna Stephens
Date Posted: 12/1/2009
It has long been known that the pallet industry is a haven for people who use their pick-up truck to collect pallets and earn some extra cash – with and without proper licensing. But as the pallet market has grown, so has the value of the underground pallet economy. Today many people are making far more than a few extra bucks through underground pallet activity.
All unreported exchanges of goods or services, both legal and illegal, are considered part of the underground economy. The general underground economy in the United States is considered one of the smallest in the world. However, almost every American over the age of 15 has probably been involved in it. It has always been around and always will be. In some ways it is so imbedded into society that people do not even realize when they are participating in it. Ever paid a neighborhood kid in cash to mow your lawn? If so, you have taken part in the underground economy. Illicit activities, such as narcotics dealing and sex trafficking, come under the same broad umbrella as babysitting.
Underground activity in the pallet industry includes the intentional misclassification of employees to avoid taxes, paying labor for cash and falsifying markings and wood treatment certification.
Over the years many labels have emerged for the underground economy - informal sector, black market, shadow economy, phantom trade, unobserved economy and more. Some define strictly illegal and illicit transactions; others refer to the transactions that fall into the morally and legally grey areas. This article looks at different underground activities within the pallet industry, some of it is legal but unreported, some of it is illegal, and most of it falls into the questionable grey area.
Tracking the underground economy is understandably difficult, making the exact size of it unknown. However, Dr. Edgar Feige, professor of economics emeritus at the University of Wisconsin-Madison and a 30-year veteran of underground economy analysis, said the current tax gap, the difference between what taxes should be paid and what are actually paid, is upwards of $500 billion a year.
The two most common factors in the growth of underground activity are increased taxes and suspicion of the government. However, growth in underground activities during a recession is also common, according to Dr. Feige.
“We do expect that when in the official economy there is an absence of job opportunities, that people will try to find work in more informal activities, particularly where they can be paid directly in cash,” said Dr. Feige. “So clearly a recessionary period will have some influence on encouraging employment in the informal sector.”
With unemployment reaching 10%, many people are looking for more options to survive the recession and jobs that pay cash are a quick and easy answer. Because of its nature, the pallet industry is especially prone to underground activity. In 2007, the pallet manufacturing and repair industry was added to California’s Economic & Employment Enforcement Coalition’s (EEEC) list of targeted industries.
“We constantly look for industries where we think there are a high proportion of illegal operations,” Robert Jones, California’s Labor and Workforce Development Agency’s deputy secretary for policy and enforcement, told the Pallet Enterprise last year. “We have added pallets because it requires little overhead, is easy to operate under the radar and uses a relatively unskilled workforce. The pallet industry will be targeted for at least the next couple of years until we can get a handle on getting some proportion of that industry in compliance.”
Since 2007, the EEEC has conducted multiple sweeps of pallet companies across California.
“The vast majority of pallet repair locations have turned out to be wholly operating in the underground economy utilizing unreported employees who are paid in cash, and who are often subjected to very dangerous working conditions,” the EEEC’s September 2009 report said.
From 2005 to 2009 there were over 500 citations and violations by pallet companies in California with fines totaling $1.5 million. Unreported wages were also found to be a large problem with $8 million in unreported wages discovered by the EEEC.
“We have found pallet repair facilities in almost all industrial and agricultural areas of the state,” the EEEC report said. “They range in size from only a few employees to some with over 10 full-time employees who have worked for the same underground employer for years. Almost all the employees work up to 10 hours per day and are paid on either a piece-rate or per-day rate with almost all receiving none of their required overtime pay.”
These types of situations are not unique to California. They exist all over the country. Fred Haman, president of Tampa Pallet in Tampa, FL, said his area is inundated with “shade tree operators.” His experience is that they are mostly small operations, many of which are one-man operations that repair pallets literally under a shade tree, in back yard or a garage.
“I don’t see these people hiring anyone,” Fred said. “If they can’t do it themselves they just don’t do it.”
“They don’t take many customers. They only have one or two or three customers at the most because they couldn’t support any more than that; but it’s enough for them to make a living and that’s all they’re interested in”
At first glance, these kinds of operations would not seem to be that big of a deal to an established company. However, one or two customers multiplied by the number of these kinds of operations that exist can quickly add up, causing a company’s profit to drop.
Fred’s company has lost many customers to these kinds of operations.
“If you had just one or two of these little guys to deal with it would not be a problem,” Fred said. “But the fact is there are so many of them that they have an impact.”
An ability to supply high volumes of pallets has protected some companies from underground competitors, though.
Steve Yelland, president of J.F. Rohrbaugh in Hanover, PA said that high volume manufacturing has kept them from having to deal with competition from small operations that cannot provide the larger quantities that his company can. His company does not deal in the recycling market, which typically would have more competition from the smaller types of underground companies.
Unfortunately, not all underground companies are small. Underground pallet activities range in size and complexity. A sharp contrast to the shade tree operators Fred has seen are the companies holding high dollar accounts that use different kinds of underground practices.
Ron Waechter from Delaware Box & Pallet Inc. located just outside the Indianapolis market has seen more intricate operations thriving on underground practices.
“It’s probably been going on for the last 10 or 15 years here in Indiana,” Ron said. “It’s just becoming more and more commonplace. When they learn that one guy is getting away with it and they realize what an advantage that gives them price-wise, I’m finding more and more sophisticated people setting up pallet businesses to operate that way.”
Ron has even seen a pallet company hire high school students, call them independent contractors, and pay them piece work. This allows the company to avoid paying payroll taxes, workers compensation and other employee overhead costs and keep costs down.
“He’s pretty shrewd and sharp,” Ron said. “He’s, quite frankly, going after some rather big accounts.”
With a little bit of street smarts, these companies can operate illegally for years.
“These guys have become pretty shrewd at knowing not to volunteer too much or the wrong information to the state,” Ron said. “The more under the radar they stay the better it works for them.”
A look at this issue would not be complete without considering another group that likes to stay under the radar – the Amish. Though their reasons for avoiding government interference are religious, not devious, in nature, some Amish business practices could be considered underground activity. Since the passage of a bill in 2004, Amish teenagers have been allowed to work in sawmills and other wood manufacturing facilities - with restrictions on what work they are allowed to do. However, all non-Amish teenagers and businesses are still subject to the federal labor laws that prohibit anyone under 16 from working in manufacturing. The Amish are also exempt from paying Social Security taxes.
Over 30 states hold Amish communities with some of the largest being in Pennsylvania, Ohio and Indiana. As a large player in the national forest products market, these exemptions do increase their competitiveness.
Because enforcement is not uniform across the states, reporting underground pallet activity is bit of a catch-22. Unlike in California, some states have no agency or department set up to deal with underground operations.
“The state of Indiana has not been aggressive at all to look for these guys,” said Ron, who has tried to alert authorities to illegal activity in his area.
Indiana passed an upgraded workers compensation law that was supposed to “put some teeth into” the enforcement, according to Ron. But he has not seen any increased enforcement resulting from it.
“I just think the states are turning a blind eye to this problem,” he said.
Other states or localities are prompt to respond to complaints, but have not gone as far as California in actively pursuing and stopping the activity.
Tampa area authorities are good at responding to complaints, according to Fred Haman.
“They are pretty effective here,” Fred said. “If they get a complaint they’ll investigate it.”
However, because of the nature of underground activity, pursuing them is not always an easy undertaking.
“It’s pretty hard to find some of these guys,” Fred said. “They might be buried in a back yard.”
Many people do not want to do the government’s job – especially if they can save themselves some money by not asking questions of a supplier. The recession has caused some pallet manufacturers to realize that doing the right thing is not always enough.
“A large and growing segment of customers are less concerned about the integrity of their vendor and more concerned about the savings they can bring,” Jim Schwab, President of Pallet Logistics of America in Irving, TX, said.
“It opened my eyes up to the desperation to save money and the fact that people will turn their head to the fact that somebody else is breaking the law to save them money,” Ron Waechter said.
Until the economy starts to turn around, underground companies may continue to win the accounts.
“In this difficult economic environment I have found that customers don’t seem to care much,” Jim Schwab said. “When I’ve brought this to their attention, in some cases and they’ll say, ‘Well, if this doesn’t work out, we can always call you back.’ It is painful because you take the steps to do the right thing, and sometimes you are not rewarded for it.”
No matter what type of underground pallet activity is prevalent in a given market, reasons for legitimate pallet companies to be concerned exist. As customers continue looking for any possible ways to lower costs, a pallet provider with lower costs is going to look more inviting than one with higher costs, regardless of whether or not that provider is operating under the law.
Because of the wide range of enforcement standards, there is no single answer for companies losing business to underground competitors. State labor departments are a good starting point to find any agencies or task forces that might exist. However, when there is nothing in place at the state level local authorities may be the best answer. They have more interest in local issues, are easier to reach and may actually know something about the company or person in question. It is usually a good idea for a major pallet company to have a decent working relationship with local law enforcement authorities. You never know when you will need them to respond to a problem.
Suspected fraudulent or underground activity related to an official treatment standard, such as ISPM-15 enforcement, should be reported to the agency with oversight for the program. In the case of heat treating to meet ISPM-15, you should contact the American Lumber Standard Committee at www.alsc.org.
The best defense for any pallet company is to ensure that it stays above ground in all its dealings. As the economy comes back, so hopefully will customers’ morals.
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