Hawaii’s Underground Economy
Unreported cash-only deals add up to $1 billion a year in unpaid taxes
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Photo: Olivier Koning
One billion dollars a year. That’s the estimated taxes in Hawaii that don’t get paid by contractors and waiters, accountants and attorneys, hairdressers and everyone else who hides all or part of their cash income.
Just about everyone contributes knowingly or unknowingly to Hawaii’s underground economy. Maybe your mechanic cuts you a deal if you pay cash, or you buy produce from a vendor at the farmers’ market who doesn’t have a general excise tax license. There’s nothing wrong with paying cash or operating a cash-only business, provided the business reports all of its taxable income. Anyone who is caught evading taxes could end up in jail.
“If you turn yourself in now, you might get off easier,” warns Kurt Kawafuchi, state director of taxation.
But the chances of getting caught are slim since cash deals are hard to track, and many who do get caught only suffer minor penalties. So the cheating continues.
If everyone paid his or her fair share of taxes, the state might not have struggled so much over this year’s $1.2 billion budget deficit, reduced public services and Furlough Fridays. But you can look at it another way: Hawaii’s cash economy also keeps thousands of hardworking people out of the unemployment lines and current on their mortgages. And overall economic activity would decline if everyone did pay all their taxes because some businesses would not be able to survive and people would have less money to spend. Lowell Kalapa, executive director of the Tax Foundation of Hawaii, argues that the state’s gray economy is just a symptom of a bigger problem: overly high taxes.
Nobody likes to pay taxes, but most people are honest and do it anyway, says Stephen Hironaka, a former IRS agent who now supervises the state’s team of criminal tax investigators. The federal tax compliance rate was 86 percent in 2001, according to the IRS National Research Program. That includes late payments and recoveries from enforcement, but still leaves 14 percent unpaid.
Legitimate vs. cheating
Businesses that cheat on their taxes have an unfair advantage over those that follow the law. Kyle Chock, executive director of the Pacific Resource Partnership, an alliance between unions and the construction industry, says unlicensed contractors and tradespeople who take cash off the books also drive down wages for the entire industry.
“To stay in business, the honest companies have to pay their workers less to compete with the guys who are cheating and that’s bad for everyone,” Chock says. In 2008, Pacific Resource Partnership launched the Play Fair in Hawaii campaign to encourage developers to adhere to the rules governing the state’s construction industry.
One of the people Chock is fighting against is someone we’ll call the Contractor, who asked that his name not be used because he is breaking the law. The Contractor started his construction business eight years ago by doing cash jobs on weekends. “We were getting paid anywhere from $150 to $300 per day,” he recalls. “I was making more money on the weekend than my weekly paycheck.” By the time he was 25, he was earning $120,000 a year while most of his friends were making $30,000 or less. In 2006, he had his best year, grossing $800,000 and reporting only half for taxes. Today, he works year-round even while much of the construction industry is at a standstill.
“I give (cash) customers three options. Option 1 is to do the job completely on the books.” About 20 percent will choose this option. Option 2 is to do the work half on the books and half off. “My name will not appear on any of the project-related paperwork, but the price of the job will be reduced by about half, and I’m not responsible for the structure or any liability once the job is over.” He still gets all the required permits and buys the materials at his discounted contractor’s rate, which will go on the books. But only half of the labor will be documented to save both parties money.
Half of his cash customers choose Option 3, which is 100 percent off the books. The customer buys all the materials and the Contractor charges $200 per worker per day – about $100 a day less than the legitimate price for labor. The customer pays cash and all the workers are paid $1,000 cash each Friday for a 40-hour week. A homeowner would save $4,000 on a renovation that takes two workers four weeks to finish.
Chock warns consumers about hunting for bargains. “Say you hire an electrician to install a ceiling fan and pay him cash,” he says. “In two weeks, if something goes wrong with the fan, you may not be able to get it repaired if you don’t have a receipt and there’s no warranty. It’s a buyer-beware scenario.”
Ron Taketa, financial secretary and business representative for the Hawaii Carpenters Union, encourages the state to target contractors and employers who exploit workers by paying them cash and not paying state-mandated insurance for workers’ compensation, disability, unemployment and health care. “They cheat the state labor department, their workers and the state tax office at a time when we should be focused on increasing our state revenues,” Taketa says. “You can’t catch every unemployed guy running around with a pickup truck and a cell phone, but I certainly think clamping down on contractors who are part of the systematic problem would be the answer.”
Photo Courtesy of Myles Breiner
Why cheating occurs
It seems inevitable that when the economy is down and unemployment is up, tax evasion increases. But tax investigator Hironaka isn’t sure that’s the case. “Whether the economy is up or down, people are still going to cheat,” he says.
Honolulu criminal defense attorney Myles Breiner disagrees and suspects that in a down economy, when competition for work is stiffer, more people will underreport their tax liabilities or won’t file at all. “I think we’re going to see more and more tax evasion cases in the years to come,” he says. “People are very resentful of the taxes they pay so they are going to be more creative at evading them.”
Resentful or not, you should pay what the law requires, says Hironaka. “As a resident of this state, you can’t take advantage of the services government offers and not be willing to fork over what you owe to pay for those services.”
The Tax Foundation’s Kalapa agrees that, by not paying their share, delinquent taxpayers shift the burden to the rest of us, but he says Legislators must share some of the blame. “If the tax burden wasn’t so heavy, then I think more people would abide by the laws,” he says. “We have some of the highest tax rates in the nation, so don’t you think people will try to evade having to pay such a heavy burden?”
In 2006, the U.S. Treasury recommended that tax laws be reformed and simplified to reduce opportunities for intentional evasion and make it easier for the IRS to enforce tax laws. Attorney Breiner describes the tax code as a labyrinth of exceptions and subexceptions. “People get CPAs because it’s full of archaic rules and it’s not hard to be confused by them.”
Breiner says it’s a tough pill to swallow when a tree trimmer with a modest income gets slammed with heavy taxes while a CEO making millions hires a hotshot accountant to find loopholes to hide income. “It’s sad because it’s the people at the bottom end of the scale that are getting taxed to death.”
But Chock isn’t accepting that as an excuse to cheat. “Sure, we’re in a tough situation and everybody’s hurting right now. But high taxes are not an excuse for bad or illegal behavior. It doesn’t give people permission to go out and cheat and start gaming the whole system.”
Who’s doing it?
“As a former prosecutor, defense attorney and, simply, as a member of the business community, it seems to me that everyone at some level participates in the gray economy,” Breiner says. “The thought that we have sort of a gray economy is a misnomer. The economy in Hawaii is gray. Period.”
Hironaka says most tax evaders are educated people, and that the problem is not simply in blue-collar fields such as construction, landscaping and plumbing. Doctors and CEOs are also guilty.
Businesses often prefer cash because checks can bounce and credit-card transactions cost money. But false income reporting is easier in industries where cash is often tendered, such as restaurants, bars or stores. “There is a temptation to not report when only cash is involved because who would know?” Hironaka says. “But then again, you can’t assume wrongdoing just because a business only takes cash.”
Since opening in 1962, Buzz’s Steak House in Kailua on Oahu has accepted only cash and checks. Manager Mani Schneider, daughter of founders Buzz and Bobby Lou Schneider, says, “When my parents applied to get a credit-card-processing system, the bank turned them down because their credit wasn’t good enough.”
Decades later, Buzz’s payment policy has remained unchanged. “It’s just the principle with my mom,” Mani Schneider says. “People always assume that we’re scamming here, but every transaction goes through Digital Dining (point-of-sale software that tracks restaurant transactions) so it’s all registered.”
Hironaka says unreported rental income is a huge problem for the state. “Let’s say a room is rented for $600 a month, times 12, that’s $7,200, times 4 percent, that’s about $300 a year,” he says. “Who’s going to check on paying GET on $300? But multiply that by the tens of thousands of people who are doing it and that $300 is not $300 anymore – it’s $3 million.”
In the past 15 years, the state Tax Department has won more than 360 criminal tax convictions, 80 percent of which were for failing to file GET returns. Those who get investigated are often those who file inaccurately or inconsistently, or who pay their income taxes but not their GET.
“The problem today is that there’s no shame anymore,” Hironaka says. “Tax avoidance or tax cheating is an acceptable method these days. How often do people inflate their numbers by just a little? To a lot of people, it’s perfectly fine to cheat a little on their tax returns.”
It’s all about trust
The Contractor says he approaches new customers carefully. “There’s a level of trust that needs to be there because the last thing I need is for them to turn me in,” he says. He’ll first make a legitimate bid. That often elicits a response along the lines of, “Ooooh, that’s more than I wanted to spend. Can we do anything to bring down the price?” Only if he feels comfortable with the customer will he then offer his cash-only discounts.
The Contractor knows he could be caught for tax evasion, but has decided the risks are worth it. “When I started off, I was broke, so I did what I had to do to survive. But, after a while, you get used to the money and the lifestyle and it kind of just grows from there,” he says. “I don’t tell people how to pay me. They approach me and the way I see it, I’m helping them and they’re helping me.”
Despite hiding much of his income, the Contractor has paid up to $30,000 a year in state and federal taxes. “Believe me, the government is getting a lot of my money,” he says. “I’m probably contributing a lot more than most people and at least I’m working. I could be sitting at home collecting unemployment and welfare checks but I’m not. Trust me, everybody is doing it. The guys that do everything by the books, they’re the ones not working right now.”
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