Jed Graham
Investors Business Daily
February 6, 2004

For nearly a year, a debate has been brewing over which of the government's employment measures is wrong.

Monthly payroll figures, derived from a survey of 160,000 employers, show a net loss of 537,000 jobs the past two years. But the monthly survey of about 60,000 households shows the U.S. has added 2.4 million jobs in that span.

In recent weeks, the Federal Reserve and the treasury secretary joined the discussion.

The Fed's policy-setting committee, while holding its key interest rate steady on January 28, noted in its inscrutable fashion, "Although new hiring remains subdued, other indicators suggest an improvement in the labor market."

Treasury Secretary John Snow was less guarded. "There is some question about the accuracy of these statistics," he said.

While Wall Street and the media tend to focus on payrolls, some economists put more faith in the household data early in a recovery, since the Labor Department has trouble tracking payrolls at new firms. But the huge gap between the surveys is unprecedented.

So which one should be believed? There's evidence to suggest that both are right. Employers, faced with global competition and surging benefit costs, have been unusually slow to add workers to their payrolls. But individuals are still getting hired on a contract basis.

The growing use of independent contractors, called 1099 workers after the tax forms companies must file, accounts for much of the disparity, some economists believe. Other big factors include a surge in the new immigrant work force and an increase in off-the-books work through which workers get paid in cash.

Michael Alter, president of Skokie, Ill.-based SurePayroll, which handles payroll services for 10,000 small business clients, is in a better position to spot the growth of 1099 employees than almost anyone, including the Labor Department. That's because in contrast to W2 employees, whose taxes are withheld each pay period, the government sees 1099 reporting only at year-end.

In 2002, independent contractors made up 4.2% of the workers whose compensation SurePayroll handled. In 2003, 1099 workers grew to 4.7% of its clients' work forces, up 12% from a year earlier.

Alter attributes the surge in contract work to firms not wanting to "lock into the higher cost structures associated with hiring employees" and an abundance of high-skilled workers looking for jobs.

Firms, Contractors Use Net

The bursting of the technology bubble "left a whole bunch of people with really good skills on the market all of a sudden," Alter said. "And the Internet has created communities that enable employers to find them," he said.

Web sites such as emoonlighter.com and elance.com are among those helping employers and contract workers find each other."We live (this trend) here at SurePayroll. We probably have 10 virtual employees we use on a contract basis," Alter said.

Such far-flung employees were harder to find and harder to manage in pre-Internet job recoveries.

Other evidence also supports the notion that more people are working, even if they're not on payrolls, says Andrew Sum, director of the Center for Labor Market Studies at Northeastern University.

He points to income data showing wages and salaries in the fourth quarter rose 2.6% from a year ago. But the income of nonfarm proprietors, which include the self-employed and independent contractors, rose a hefty 6.8%.

It's not just laid-off tech workers doing contract work. Sum and his colleagues found anecdotal evidence that it's happening in manufacturing, construction and retail.

And Sum notes that the data reflect only reported income. The Internal Revenue Service estimates an $81 billion tax gap due to income not reported by contract workers.

The Center for Labor Market Studies found off-the-books workers at firms in landscaping, construction, food services, cleaning services, carpentry, home care and auto repair.

"There's a lot of off-the-books work, particularly among undocumented workers," Sum said.

Indeed, new immigrants may account for a big part of the payroll-household data disparity, he says.

Sum's group, analyzing data from the Labor Department's monthly household survey, estimate that 1.7 million to 1.9 million immigrants who arrived from 2001 to 2003 were working last year.

Most held wage and salary jobs in the private sector. But "informal evidence suggests that many of them were employed as contract workers and in the informal economy rather than on the formal payrolls of these firms," the report concludes.

Contract workers aren't just a reality at small firms, says Irene Cohen, founder of FlexCorp Systems, which helps Fortune 1000 clients manage contingent work forces.

"We are seeing a major adjustment in the economy," Cohen said. "We are seeing more and more corporations using more and more project workers. What's driving this, No. 1, is health care."

The labor market is really weaker than the 5.7% jobless rate, which is derived from the household survey, would suggest, Sum says. "But if these flexible arrangements didn't exist, the jobless rate would be 8%."

Economists expect today's January employment report to show payrolls rising by 175,000, with the jobless rate steady at 5.7%. But big annual benchmark revisions could substantially change the outlook.

Copyright © 2004. Investors Business Daily.