The Black Market for Labor

One of the things that strikes me about the public discussion going on about immigration reform these days is the failure to recognize that there’s a substantial demand for off-the-books labor and no conceivable immigration reform will address that. If you legalize all of the immigrant workers presently working here illegally and they all start paying taxes, having FICA deducted from their paychecks, etc. one of several things will happen.

The first possibility is that the workers will take the pay cut. How much are we talking about? Let’s use Illinois as an example. Here in Illinois the minimum wage is $8.25 per hour. If you’re an off-the-books worker receiving $7.25 per hour, you’re costing your employer $7.25 an hour plus some probably nominal amount of administrative overhead. There’s also a risk premium involved but the risks to the employer are so small that can probably be discounted. If the worker goes on the books and everything is on the up and up, all other things being equal the cost to the employer of that worker is $8.25 per hour plus 6.2% FICA, the “employer contribution”, and 1.45% for the employer contribution for the Medicare tax or an additional 7.65%. Total cost per hour borne by the employer will then be $8.88 per hour, $1.63 per hour (22%) more. We’ve already established that the employer is a scofflaw. Unless the penalties are increased substantially and the likelihood of discovery increased considerably, that employer has a powerful inducement to look for another, different worker who’ll work off the books. The new taxes being imposed for ObamaCare make legal employees that much more costly but I don’t even want to get into that here.

The situation for the employee is even worse. The newly on-the-books employee will have his or her pay increased by $1 but that pay will be reduced to $7.61 when Social Security and Medicare are deducted. In addition, there’s 10% withholding on the first $8,700 of income, 15% on the balance of annual income. That means the actual takehome pay for that employee will be $6.79 per hour. For the employee the net effect of legalization is a loss of nearly $.50 an hour. It’s estimated that at least 26% of illegal immigrants are illegally paid below minimum wage. That doesn’t even consider agricultural workers for whom the rules are somewhat different.

Clearly, these employees have a substantial incentive not to seek legalization. Legalization will get them a pay cut and may even cause them to lose their jobs.

The second possibility is that the employer will eat the difference. My little back-of-the-envelope example should be enough to convince you that will not be the case. Consider, too, how many businesses operate on very tight margins.

It seems to me that the third possibility is the most likely: legalization will incentivize hiring other, different, still-illegal workers.

There’s a solution to all of these problems: abolish FICA and don’t even require withholding or reporting for workers earning minimum wage. I’ll leave the calculations for what that would mean in lost revenue to the interested reader.

The bottom line on all of this is that there’s a substantial black market for labor in the United States, our system incentivizes it, and immigration reform is unlikely to change that.

6 comments… add one
  • PD Shaw

    More simply, I had to read numerous stories about the plight of the poor Alabama tomato farmer who cannot afford legal labor of the quality he needs. (Apparently prison inmates lack good work ethic, who knew?) What is immigration reform supposed to change?

  • Sam

    Did you leave out EITC because immigrants wouldn’t be able to get it? The EITC should at least be big enough to make it in a newly legal immigrant’s interest to file taxes and offset the debits you mention.

  • Icepick

    Funny how the current tax system gives employers incentives to break the law and hire illegals. Why, it’s almost like that’s what the people running the country want!

    Again, are the leaders completely stupid, or is this what they want?

  • Icepick

    I’ll also note that a pure consumption tax, in replacement of an income tax, would eliminate some of these incentives to hire illegals.

  • We don’t know who’ll be eligible for EITC, Sam. The law isn’t written yet.

  • Drew

    Dave, you are so correct here.

    Because Texas is such a relatively robust economy and business friendly environment we have looked at (and owned several) a number of businesses there. But we are always wary of the illegals. We don’t play that game.

    I’m an interested reader, but won’t do the calculations. I can’t imagine that your point isn’t that the needle doesn’t move materially. I have a problem with that, I think everyone should have skin in the game, but then again I’m an equity guy.

    The illegals issue is complex. The libertarian bent in me says let people strive for all they can be; give them opportunity. But we (the left, that is) have bastardized this through government to “get all you can at the expense of someone else, if you will vote for me.” And then when in power make amends with your agrieved union base.

    The US is certainly a resilient place, but I wonder if the rubber band isn’t reaching the breaking point.

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