Susan Morse

Workers who provide child care in children’ homes—that is, nannies—should almost always be “formal” workers based on existing law. But in fact they are almost always treated as “informal” workers paid off the books and not as employees. Formality would mean more work law protection – that is, from labor, employment, and social insurance law. But it would also mean more income and payroll taxes.

Is going formal worth it?

In Taxing Nannies, Ariel Jurow Kleiman, Shayak Sarkar, and Emily Satterthwaite consider this question from an obvious yet original perspective. They focus on the preferences and welfare of nannies, not hirers. Their empirical work shows that some nannies strongly prefer formality. It also suggests that the market assumes informality and quotes compensation on an after-tax basis. A tax incidence negotiation between nannies and hirers results over how to split the tax burden of going formal, and diverse solutions follow.

The authors analyzed data from the online platform Reddit, using a strategy similar to that used by Shu-Yi Oei and Diane Ring to investigate the tax lives of rideshare drivers. Kleiman, Sarkar, and Satterthwaite examined about three hundred posts from the “r/nanny” subreddit. They found that 81% of the 150 or so posts that consider worker classification express a preference for formal employee status, for reasons including legal compliance and needing documentation. The documentation preference connected to both public benefits reasons, for instance unemployment insurance or Section 8 housing vouchers; and private market reasons, for example apartment or mortgage loan applications. The authors found a similar result when they survey 57 predominantly female, white, documented, and highly paid nannies. Seventy-five percent of their survey respondents preferred formal employee treatment, and most of these offered legal or tax compliance—not, for example, dignity or professionalism—to explain their preference.

Kleiman, Sarkar, and Satterthwaite also interviewed 15 experts, including from payroll service providers, nanny membership groups, and workers’ rights organizations. (P. 54.) Some interviewees characterized the nanny work sector as a “cash industry” (P. 56.) with a strong default norm of informality. But others observed a sea change toward formality, especially because of the collateral benefits of documentation for public benefit and private market purposes. The experts also cited hirer-side motivations such as reputational concerns.

Kleiman, Sarkar, and Satterthwaite are careful not to generalize their finding of a preference for formal work among some nannies.  They acknowledge that lower-wage nannies might have different preferences, and that undocumented workers in particular might prefer informal status. (P. 38.) But they write that their work invalidates “the null hypothesis that nannies as a whole prefer informality over formality.” (P. 9.)

If some nannies prefer formal work, then who will pay for the taxes that are the price of formality? Some of the most interesting posts uncovered by the paper reveal the negotiation over the tax incidence of going formal. Nannies’ wages historically have been quoted after tax—a practice that “diverges from nearly all employment sectors” (P. 46.) since employee wages are almost always quoted on a gross basis, before income tax or employee-side payroll tax. Thus, going formal raises an unusual incidence question: How to split the burden of a voluntary agreement to pay more in tax.

The paper suggests that nannies often focus on the practice of quoting post-tax wages, which implies that hirers should bear the tax burden, while hirers sometimes focus on the practice of quoting pre-tax wages in the rest of the employment market, which implies that nannies should bear most of the tax burden. For instance, one Reddit post endorsed by 232 upvotes compared a nanny’s belief that her hirer was “responsible for taxes as an employer” to the hirer’s statement that “I don’t know if we can afford to pay you $25 and pay your taxes.” (P. 46.) When nannies and hirers negotiate over such disagreements, a diversity of agreements results.

For instance, some hirers agree to “gross up” nannies’ pay, by paying in cash the amount of tax withheld. (P. 46.) (The gross-up cash is, of course, also taxable compensation income that should be reported.) Other hirers may offer some compensation on the books and some off the books; cash payments might be made for overtime, for instance, or, in some carefully negotiated cases, for amounts that would cause compensation to exceed benefit cliff limits for programs such as Section 8 housing vouchers or Medicaid. Other hirers may consider a nanny to be an independent contractor subject to tax reporting requirements but may allow the nanny to believe that their arrangement is off the books; later, when the hirer presents the nanny with a 1099, it is often an unpleasant surprise.

The evidence presented by the paper shows that some nannies prefer formal arrangements, and that these preferences may also assume that hirers will bear the resulting tax burden. But the paper also presents evidence of nanny-hirer negotiations, which shows that going formal often requires nannies, as well as hirers, to bear some of the burden of the increase in tax. The work law protections may come at a price, counter to the assumptions of at least some proponents of greater enforcement and formality.

The authors make three policy suggestions intended to ease this tension. First, they propose to save on transaction costs by simplifying compliance. Second, they endorse immigration reform, including a special path to work status for caregivers. Increasing the proportion of documented nannies should encourage more unified support of the move toward formal work and perhaps improve the bargaining position of nannies in general. Third, they suggest expanded public benefit systems, including specific benefits for caregivers, to mitigate the effect of benefits cliffs that encourage some off-the-books compensation for nannies.

The last idea of expanded public benefits specifically targets the problem of going formal. It injects value into the hirer-worker negotiation to offset the value lost to the burden of paying tax in a formal arrangement. The authors do not detail a social reproduction theory or other justification for singling out the child care labor market for extra government support. But regardless of any theoretical takeaway, this paper’s fascinating empirical analysis is highly recommended. It reveals key details about this important corner of the labor market, and about that market’s ongoing struggle with the benefits, costs, and tax incidence of going formal.