Examining Motivators in Understanding Underground Economy Participation in the Construction and Restaurant Sectors

Prepared for the:
Public Affairs Branch
Canada Revenue Agency
FINAL REPORT
June 2008
POR# 339-07
Contract #46558-098175

Prepared by:
Sage Research Corporation

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Executive summary

The purpose of the focus group research was to explore awareness, attitudes and behaviours regarding underground economy (UE) issues among participants in high-risk sectors with the aim of understanding the drivers that shape these attitudes and behaviours. Based on previous research commissioned by the Federal, Provincial, Territorial Underground Economy Working Group (FPTUEWG) and Canada Revenue Agency (CRA) internal data, it was decided to conduct the research with participants in the construction and restaurant/bar/catering (RBC) sectors. The research examined the drivers and values underlying attitudes of non-compliance in these two industries. This research was intended to help shed light on the factors that shape tax compliance, and will be used to help direct current and future strategies and initiatives to address the underground economy.

Twenty focus groups, split equally between the Construction and RBC sectors, were conducted February 18-28, 2008, in Halifax, Montréal, Toronto, Edmonton, and Vancouver. Within each sector, half the focus groups were with small businesses, and half with medium-sized businesses.

Role of General Taxation-Related Attitudes

For each type of UE activity, there are particular factors involved which can either encourage or discourage participation in the activity, and these factors differ somewhat between the Construction and RBC sectors. However, there is also a more general backdrop of taxation-related attitudes and values which can operate to either discourage or to justify UE participation, and at this more general level the two sectors were very similar. Key points include:

• A very important general value that limits participation in the UE is the desire to be an honest, law-abiding person. Many participants said a reason why a business person would limit their participation in UE activities is because the person wants to run an honest, legitimate business.
  
  
• A basic factor perceived to drive the UE is, as some participants put it, "greed" -- i.e., a desire to have more money rather than less.
  
  
• A person who evades a very large amount of tax, is generally seen as committing a crime and deserving to be punished. However, there are more mixed views of "small" tax evaders, and some degree of evading tax is quite often seen as justifiable.

Types of UE activities

In both the RBC and Construction focus groups, the two main perceived types of UE activity are:

• Paying workers off the books: This refers to paying a person working for the business in cash without completing any of the paperwork required for a regular employee, and without deducting/remitting any government-related source deductions such as income tax, EI, or provincial occupational health and safety (OHS) premiums. Associated with the lack of source deductions, the cost to the employer is typically lower.
  
  
• Hiding income: In a restaurant or bar, this can mean not recording all sales on the cash register, while in the case of catering this means doing a cash job for a customer and not charging/remitting sales tax or declaring the income. In the Construction sector, this means doing jobs for cash and not charging/remitting sales tax or declaring the income.

The details of these two types of UE activity are different in the RBC and Construction sectors, but there are some basic similarities in the drivers, as well as some differences. In the summary below, drivers specific to a sector are flagged.

Note that the fundamental drivers of UE activity described in the previous section on the role of general taxation-related attitudes apply equally to both types of activity -- that is, to paying workers off the books and to hiding income.

Paying Workers Off the Books

Factors associated with greater likelihood of paying workers off the books

Factors common to both the RBC and Construction sectors included:

• Short-term work: Many participants said that workers who are with the business for only a short period of time are more likely to be paid off the books, because of the perceived time and cost of doing the proper paperwork.
• Workers may ask to be paid off the books: This is quite common, and participants mentioned various types of people who might ask to be paid off the books -- for example, people with regular jobs who want to earn extra money without paying tax on the extra income, people who receive government benefits such as EI or social assistance which are income tested and who do not want to lose any of these benefits, and newcomers to Canada who do not have legal working status in Canada.
• Labour shortages: Participants in both sectors and in all cities complained of labour shortages, although this was particularly an issue among the Edmonton participants, reflecting the general labour shortages currently affecting Alberta. The labour shortage, combined with some workers' preference to be paid off the books, can sometimes leave an employer with a feeling they have no choice other than to hire a worker off the books.
• Business is struggling financially: For these businesses, paying workers off the books can cut labour costs.

A factor specific to the RBC sector was tip pooling, which refers to sharing tips with non-wait staff to provide these other workers with added incentive. The impression is that the tip pooling is often done in cash.

Some factors specific to the Construction sector include:

• Residential home renovation: Workers on home renovation job sites are perceived to be more likely to be paid off the books because of the much higher perceived incidence of cash jobs in the home renovation market.
• Subtrades on commercial jobs: The general view was that the likelihood of paying workers off the books is much lower for commercial jobs than for home renovation jobs. However, to the extent it does happen on commercial jobs, participants tended to see it as involving the subtrades and not the main contractor.
• Lower-skilled or lower-risk work: For example, some participants believed that for types of work where the risk of injury is perceived to be lower, a contractor may be more willing to pay the worker off the books.

Factors associated with lower likelihood of paying workers off the books

Factors common to both the RBC and Construction sectors included:

• Fear of getting caught by the CRA (additional detail on this is provided later in the Executive Summary)
• Ability to declare labour costs as an expense: Quite a few participants noted that an important reason not to pay workers off the books is so that one can declare the labour costs as an expense when filing a tax return for the business. Paying employees off the books was described as essentially taking money from the business owner's pocket, because the owner is paying tax on the money paid to the workers. This creates a strong financial incentive to avoid or strictly limit the amount in wages paid out off the books.
• Liability in the event of injury: Participants viewed the consequences to be severe if a worker paid off the books, and therefore not covered by workers compensation or insurance, is injured on the job. Notably, though, this factor was much more likely to be mentioned by the Construction participants than the RBC participants -- perhaps because of differences between the sectors in the perceived riskiness of the work.
• Complexity of management systems: Larger businesses were perceived to be less likely to pay employees off the books because of the management systems in place, where multiple people are involved in approving and reviewing hiring-related expenditures.
• Work for commercial customers: Commercial customers are widely perceived to be less likely to pay for work in cash, which in turn makes it more difficult to pay workers in cash. Note that this was a major factor in the Construction sector, but in the RBC sector it was significant only in the catering subsector.
• Risk of worker disclosure: Some participants said they would be concerned about workers who are paid off the books revealing this fact to a regulator. For example, a worker paid off the books who leaves might subsequently apply for EI and declare their employment.

A factor specific to the RBC sector pertained to the focus groups in Quebec, and a law there requiring restaurants and bars to consider a minimum of 8% of all sales and tips, and to account for this in the source deductions for wait staff and bartenders. This was perceived as creating a disincentive to pay these types of employees off the books.

Hiding Income

Factors associated with greater likelihood of hiding income

Factors common to both the RBC and Construction sectors included:

• Unregistered businesses that work entirely or almost entirely underground: This is widely considered a very significant factor in the home renovation sector, and some considered it a factor in the catering business.
• Business is struggling financially: These sorts of businesses are perceived to be more likely to hide some income. While this can apply to any business, participants noted that it can often apply to businesses that are starting up.

In addition to the usual issues a start-up business may face, participants commented on additional issues specific to each sector that can add to a start-up's financial difficulties. RBC participants mentioned the general difficulty RBC businesses have in getting bank loans, and the problem of people opening a restaurant or bar who do not know much about the business. Construction participants mentioned: a tradesperson starting a business knows their trade but may not know how to run a business, a person starting up may not know how to properly bid a job and end up underbidding it, and start-up businesses may be undercapitalized which can lead to a need to do cash jobs in order to generate cash flow.

• Business owner has close control of operations: Hiding income is perceived to be easier if the owner is in direct control of operations. For example, in the case of restaurants and bars, this was described as "control of till", meaning the owner has direct control over what goes into the cash register. Close control of operations was seen as more characteristic of small businesses than of larger businesses.
• Business objectives are short-term or no-growth: If the owner has a short-term focus, they may be more inclined to take as much income out of the business as possible by hiding some of it. If the owner achieves what they consider to be a comfortable income and comfortable work hours, this may also lead to an inclination to maximize income from the business by hiding some.
• A business pays some workers off the books: That is, the two types of UE activity are interconnected -- if some workers are paid off the books, then financially it could be preferable to hide income in order to pay the wages.

A factor specific to the RBC sector pertained to the types of businesses in the sector most likely to have a high level of customer payment via cash -- which then creates an opportunity to hide some cash. Because of the use of debit and credit card transactions, some restaurants receive only a small percentage of their sales in cash. Participants mentioned the following types of businesses that have a higher percentage of cash: bars and nightclubs because of the way drinks are usually paid for, restaurants that sell low-cost items (e.g., coffee shops), food delivery, and establishments that accept only cash.

Some factors specific to the Construction sector include:

• Residential home renovation: Most participants working in the home renovation sector said it is common for some homeowners to ask that the job be done in cash. Associated with this, participants widely felt that most underground activity in construction happens in the home renovation market.
• Smaller jobs: Many participants believed the UE is mostly limited to smaller jobs, for several reasons including difficulty of financing large jobs using cash, permits are less likely to be required for small jobs, and the customer may be less concerned about not having a formal warranty.
• A need to maintain steady income and work for employees: Because of the project-driven nature of construction, there can be down times, and some participants commented that in an environment of labour shortages, it is difficult to hold on to employees if there is not steady work. This can lead to taking on a cash job when no above-ground job is immediately available.

Factors associated with lower likelihood of hiding income

Factors common to both the RBC and Construction sectors included:

• The business is financially successful: Some participants said that when a business is financially successful, an owner may feel less need to incur the perceived risks of participation in the UE (additional detail on perceived risks and consequences is provided later in the Executive Summary).
• Business objectives are long term or growth oriented: Participants said if an owner has a long-term focus, including the possibility of expanding or eventually selling the business, this creates a strong incentive to declare all income in order to (a) increase the likelihood of being able to get a bank loan or investor financing, and (b) to make the business attractive to potential buyers.
• Complexity of management systems: Participants note that the more different parties within a business have access to and control over income and expenditures, the harder it is to hide some income. For this reason, larger businesses were perceived as less likely to be involved in hiding income. Another issue mentioned for larger companies is the difficulty of managing large amounts of cash in the business.
• Commercial customers: This was a major factor in the Construction sector, and was also a factor for the catering subsector. Commercial (and industrial) customers are perceived to be much less likely to want to pay in cash. These customers do not want an underground transaction because they want to be able to declare the expense on their tax return. As well, in the Construction sector, commercial/industrial customers were perceived to be more aware of and concerned about liability issues associated with cash jobs.

A factor specific to the RBC sector pertained to the types of businesses in the sector least likely to have much cash income. This was perceived to be medium-priced to more expensive restaurants, where a high proportion of sales occur via debit or credit card.

Some factors specific to the Construction sector include:

• Liability: On cash jobs the owner will not have insurance coverage, and so could have personal liability if there is damage to the worksite or injuries to third parties.
• Larger construction jobs.
• Protection against not being paid: Quite a few participants said a reason not to do a job for cash and instead do one with a proper contract is to ensure the contractor gets paid.

Perceived Relationships Between Business Size and Likelihood of UE Activity

In both the RBC and Construction sectors, participants tended to feel that the likelihood of UE activity is greater among smaller businesses than larger businesses.

Perceived Relationships Between Business Life Cycle and Likelihood of UE Activity

One of the topics of interest in the research is whether there is a correlation between business life cycle and attitudes towards or participation in the UE, particularly with respect to the prototypical pattern of a business starting small, struggling for a few years to get established, and then achieving a reasonable level of sustained success.

• While to a degree some participants saw a connection between business life cycle and likelihood of UE activity, participants also made it very clear that personal character and motivation is an overriding factor: a person who is honest and wants to run a legitimate business will try to do this at all stages of the business, and a person willing to cheat the government will do this at all stages of the business.
• That said, with respect to the prototypical pattern noted above, some participants did feel that participation in the UE may be more likely in the start-up phase of a business -- i.e., for a small business struggling to get established.
• While there tended to be some agreement among participants that there is some likelihood of UE activity at the start-up phase of a business, the predictive power of business life cycle effectively dropped with respect to the stage where a business becomes moderately successful. The reason is that what the owner does at this point is driven by their character and their business objectives. As well, in the Construction sector, it also depends on whether the business is operating in the home renovation market, where the UE is generally perceived to be most prevalent.

Another way in which business life cycle may be related to participation in the UE is whether the perceived reward vs. risk changes as a business becomes more established and successful. As noted earlier, some participants did feel there can be change, and that when an owner achieves financial success and stability they may feel less need to incur the perceived risks of participation in the UE.

Perceived likelihood and consequences of getting caught

In both the RBC and Construction sectors:

• The majority of participants had not heard of any business in their sector getting caught by the CRA in the past few years for UE activity. In this context, participants tended to assume the risk of getting caught by the CRA is relatively low, although some were not sure.
• Associated with low awareness of businesses getting caught by the CRA for tax-related UE activity, there was very little specific awareness of what the consequences of getting caught might be.

It is important to note that there are perceived risks associated with UE activity that are not tax-related, but which can potentially impact attitudes and behaviour. These fall into areas of provincial jurisdiction involving health and safety. Participants viewed these as being very serious matters, with the power to have an immediate and major adverse impact on a business. With regard to initiatives to combat the UE, it could useful to coordinate efforts with the provinces in these areas.

Fear of Getting Caught and "Reputation"

Some participants spontaneously phrased the fear of getting caught in terms of impact on "reputation":

• It is important to distinguish between impact on personal reputation and impact on business reputation -- i.e., whether the business would lose customers or not.
  
  Impact of getting caught on personal reputation can be very important, but it was noted that the significance of this will depend on the person. Some people would be really bothered by the impact on their personal reputation, but others may not see it as a big deal.
• With regard to impact on business reputation, there was a major perceived difference between private individuals as customers and commercial customers.
  
  Most participants felt that getting caught for tax evasion would have no impact on a restaurant, bar, a person who caters events for private individuals, or a home renovation business. Private individuals are perceived to care about quality and price, and to not care much about whether a business owner has been caught for tax evasion -- unless the amount of tax evaded is very large.

However, most participants thought that commercial construction or catering customers would react negatively if a contractor was caught for tax evasion. There were two main perceived reasons: (1) corporate/industrial customers are likely to have the attitude, "if you are cheating the government, you might be cheating me", and (2) corporate/industrial customers are more likely to be aware of and concerned about liability issues with construction work that is done underground.

Date modified:

2008-12-18