    [House Hearing, 108 Congress]
    [From the U.S. Government Publishing Office]

                          UNEMPLOYMENT FRAUD AND ABUSE

    =======================================================================

                                    HEARING

                                   before the

                           SUBCOMMITTEE ON OVERSIGHT

                                      and

                        SUBCOMMITTEE ON HUMAN RESOURCES

                                     of the

                          COMMITTEE ON WAYS AND MEANS
                         U.S. HOUSE OF REPRESENTATIVES

                          ONE HUNDRED EIGHTH CONGRESS

                                 FIRST SESSION

                                   __________

                                 JUNE 19, 2003

                                   __________

                               Serial No. 108-25

                                   __________

             Printed for the use of the Committee on Ways and Means

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                          COMMITTEE ON WAYS AND MEANS

                       BILL THOMAS, California, Chairman

    PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
    E. CLAY SHAW, JR., Florida           FORTNEY PETE STARK, California
    NANCY L. JOHNSON, Connecticut        ROBERT T. MATSUI, California
    AMO HOUGHTON, New York               SANDER M. LEVIN, Michigan
    WALLY HERGER, California             BENJAMIN L. CARDIN, Maryland
    JIM MCCRERY, Louisiana               JIM MCDERMOTT, Washington
    DAVE CAMP, Michigan                  GERALD D. KLECZKA, Wisconsin
    JIM RAMSTAD, Minnesota               JOHN LEWIS, Georgia
    JIM NUSSLE, Iowa                     RICHARD E. NEAL, Massachusetts
    SAM JOHNSON, Texas                   MICHAEL R. MCNULTY, New York
    JENNIFER DUNN, Washington            WILLIAM J. JEFFERSON, Louisiana
    MAC COLLINS, Georgia                 JOHN S. TANNER, Tennessee
    ROB PORTMAN, Ohio                    XAVIER BECERRA, California
    PHIL ENGLISH, Pennsylvania           LLOYD DOGGETT, Texas
    J.D. HAYWORTH, Arizona               EARL POMEROY, North Dakota
    JERRY WELLER, Illinois               MAX SANDLIN, Texas
    KENNY C. HULSHOF, Missouri           STEPHANIE TUBBS JONES, Ohio
    SCOTT MCINNIS, Colorado
    RON LEWIS, Kentucky
    MARK FOLEY, Florida
    KEVIN BRADY, Texas
    PAUL RYAN, Wisconsin
    ERIC CANTOR, Virginia

                        Allison H. Giles, Chief of Staff

                      Janice Mays, Minority Chief Counsel

                                     ______

                           SUBCOMMITTEE ON OVERSIGHT

                        AMO HOUGHTON, New York, Chairman

    ROB PORTMAN, Ohio                    EARL POMEROY, North Dakota
    JERRY WELLER, Illinois               GERALD D. KLECZKA, Wisconsin
    SCOTT MCINNIS, Colorado              MICHAEL R. MCNULTY, New York
    MARK FOLEY, Florida                  JOHN S. TANNER, Tennessee
    SAM JOHNSON, Texas                   MAX SANDLIN, Texas
    PAUL RYAN, Wisconsin
    ERIC CANTOR, Virginia
                        SUBCOMMITTEE ON HUMAN RESOURCES

                       WALLY HERGER, California, Chairman

    NANCY L. JOHNSON, Connecticut        BENJAMIN L. CARDIN, Maryland
    SCOTT MCINNIS, Colorado              FORTNEY PETE STARK, California
    JIM MCCRERY, Louisiana               SANDER M. LEVIN, Michigan
    DAVE CAMP, Michigan                  JIM MCDERMOTT, Washington
    PHIL ENGLISH, Pennsylvania           CHARLES B. RANGEL, New York
    RON LEWIS, Kentucky
    ERIC CANTOR, Virginia

    Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
    hearing records of the Committee on Ways and Means are also published
    in electronic form. The printed hearing record remains the official
    version. Because electronic submissions are used to prepare both
    printed and electronic versions of the hearing record, the process of
    converting between various electronic formats may introduce
    unintentional errors or omissions. Such occurrences are inherent in the
    current publication process and should diminish as the process is
    further refined.

                                C O N T E N T S

                                   __________
                                                                       Page
    Advisories announcing the hearing................................     2

                                   WITNESSES

    U.S. Department of Labor, Hon. Mason Bishop, Deputy Assistant
      Secretary, Employment and Training Administration..............     9
    U.S. General Accounting Office, Robert J. Cramer, Managing
      Director, Office of Special Investigations; accompanied by Paul
      Desaulniers, Special Agent, Office of Special Investigations...    19

                                     ______

    Employment Security Commission of North Carolina, David L. Clegg.    37
    Kelly Services, Inc., Carl Camden................................    44

                           SUBMISSION FOR THE RECORD

    National Association of Professional Employer Organizations,
      Alexandria, VA, statement......................................    57

                          UNEMPLOYMENT FRAUD AND ABUSE

                                  ----------

                            THURSDAY, JUNE 19, 2003

             U.S. House of Representatives,
                   Committee on Ways and Means,
                             Subcommittee on Oversight,
                               Subcommittee on Human Resources,
                                                        Washington, DC.
        The Subcommittees met, pursuant to notice, at 2:05 p.m., in
    room 1100, Longworth House Office Building, Hon. Wally Herger
    (Chairman of the Subcommittee on Human Resources) presiding.
        [The advisory and the revised advisory announcing the
    hearing follow:]

    ADVISORY

    FROM THE
    COMMITTEE
     ON WAYS
    AND
    MEANS

                        SUBCOMMITTEE ON HUMAN RESOURCES

                                                    CONTACT: (202) 225-7601
    FOR IMMEDIATE RELEASE
    June 10, 2003
    OV-5

     Houghton and Herger Announce Joint Hearing on Unemployment Fraud and
                                     Abuse

        Congressman Amo Houghton (R-NY), Chairman of the Subcommittee on
    Oversight, and Congressman Wally Herger (R-CA), Chairman of the
    Subcommittee on Human Resources, Committee on Ways and Means, today
    announced that the Subcommittees will hold a joint hearing on
    unemployment fraud and abuse. The hearing will take place on Tuesday,
    June 17, 2003, in the main Committee hearing room, 1100 Longworth House
    Office Building, beginning at 2:00 p.m.

        In view of the limited time available to hear witnesses, oral
    testimony at this hearing will be from invited witnesses only.
    Witnesses will include representatives of the U.S. Department of Labor
    (DOL), U.S. General Accounting Office (GAO), and other interested
    individuals.

    BACKGROUND:

        The Unemployment Compensation (UC) program (sometimes referred to
    as Unemployment Insurance or UI) is a State-Federal partnership under
    which benefits are paid to laid-off workers who have a history of
    attachment to the workforce. Within a broad Federal framework, each
    State designs its own UC program.

        Federal payroll taxes paid by employers support Federal
    responsibilities in the unemployment system, including certain
    administrative expenses, loans to States, and the Federal half of costs
    under the permanent Extended Benefits (EB) program. State payroll taxes
    support regular unemployment benefits and the State half of the EB
    program, among other costs. Both the Federal and State taxes collected
    for unemployment purposes are held in trust fund accounts that are part
    of the unified Federal budget.

        Employers may be eligible for a lower State payroll tax rate based
    on the experience of their employees in collecting unemployment
    benefits. States use a variety of experience rating systems to assign
    tax rates to employers, with those whose employees receive benefits the
    least having lower tax rates, and those employers whose employees
    receive benefits most frequently having higher rates. These rates can
    change yearly, based on annual computations.

        A December 31, 2002, Program Letter issued by the DOL alerted
    States to ``State Unemployment Tax Act (SUTA) dumping'' activities
    designed to undermine effective experience rating. The DOL highlighted
    approaches used by some employers to avoid high unemployment tax rates,
    including various ``shell'' transactions involving the artificial
    manipulation of corporate structures or employees. Such activity,
    according to DOL, ``compromises experience rating systems by
    eliminating the incentive for employers to keep employees working and
    returning claimants to work as soon as possible, and unfairly shifts
    costs to other employers.'' Some, but not all States, have enacted
    legislation designed to prevent SUTA dumping.

        In announcing the hearing, Chairman Houghton stated, ``I have to
    believe that congressional oversight is critical to the integrity of
    the UC program. This hearing will basically review whether tax
    strategies have undermined the program, and if so, what can be done to
    fix it.''

        Chairman Herger said, ``The Nation's UC program provides a much
    needed safety net to workers laid off through no fault of their own.
    State Unemployment Tax rate manipulation, or SUTA dumping threaten
    workers, employers, and States by slowing returns to work, shifting
    taxes from businesses responsible for layoffs to other employers, and
    undermining trust fund solvency. This hearing will review the extent of
    this activity, what its effects have been, and what, if any,
    legislative action is needed to protect workers and employers who play
    by the rules.''

    FOCUS OF THE HEARING:

        The hearing will focus on ``SUTA dumping.''

    DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

        Please Note: Due to the change in House mail policy, any person or
    organization wishing to submit a written statement for the printed
    record of the hearing should send it electronically to
    hearingclerks.waysandmeans@mail.house.gov, along with a fax copy to
    (202) 225-2610, by the close of business, Tuesday, July 1, 2003. Those
    filing written statements who wish to have their statements distributed
    to the press and interested public at the hearing should deliver their
    200 copies to the Subcommittee on Oversight in room 1136 Longworth
    House Office Building, in an open and searchable package 48 hours
    before the hearing. The U.S. Capitol Police will refuse sealed-packaged
    deliveries to all House Office Buildings.

    FORMATTING REQUIREMENTS:

        Each statement presented for printing to the Committee by a
    witness, any written statement or exhibit submitted for the printed
    record or any written comments in response to a request for written
    comments must conform to the guidelines listed below. Any statement or
    exhibit not in compliance with these guidelines will not be printed,
    but will be maintained in the Committee files for review and use by the
    Committee.

        1. Due to the change in House mail policy, all statements and any
    accompanying exhibits for printing must be submitted electronically to
    hearingclerks.waysandmeans@mail.house.gov, along with a fax copy to
    (202) 225-2610, in WordPerfect or MS Word format and MUST NOT exceed a
    total of 10 pages including attachments. Witnesses are advised that the
    Committee will rely on electronic submissions for printing the official
    hearing record.

        2. Copies of whole documents submitted as exhibit material will not
    be accepted for printing. Instead, exhibit material should be
    referenced and quoted or paraphrased. All exhibit material not meeting
    these specifications will be maintained in the Committee files for
    review and use by the Committee.

        3. Any statements must include a list of all clients, persons, or
    organizations on whose behalf the witness appears. A supplemental sheet
    must accompany each statement listing the name, company, address,
    telephone and fax numbers of each witness.

        The Committee seeks to make its facilities accessible to persons
    with disabilities. If you are in need of special accommodations, please
    call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
    business days notice is requested). Questions with regard to special
    accommodation needs in general (including availability of Committee
    materials in alternative formats) may be directed to the Committee as
    noted above.

                       * * * NOTICE--CHANGE IN DATE * * *

    ADVISORY

    FROM THE
    COMMITTEE
     ON WAYS
    AND
    MEANS

                        SUBCOMMITTEE ON HUMAN RESOURCES

                                                    CONTACT: (202) 225-7601
    FOR IMMEDIATE RELEASE
    June 12, 2003
    OV-5-Revised

        Change in Date for Joint Hearing on Unemployment Fraud and Abuse

        Congressman Amo Houghton, (R-NY), Chairman of the Subcommittee on
    Oversight, and Congressman Wally Herger, (R-CA), Chairman of the
    Subcommittee on Human Resources, Committee on Ways and Means, today
    announced that the joint hearing on unemployment fraud and abuse,
    previously scheduled for Tuesday, June 17, 2003, at 2:00 p.m., in the
    main Committee hearing room, 1100 Longworth House Office Building, will
    be held, instead on Thursday, June 19, 2003, at 2:00 p.m.

        All other details for the hearing remain the same. (See
    Subcommittee Advisory No. OV-5 released on June 10, 2003.)

        Chairman HERGER. Good afternoon, and welcome to today's
    hearing on Unemployment Fraud and Abuse. It is a pleasure to be
    here with Chairman Houghton and other Members of the
    Subcommittee on Oversight.
        This Congress is very aware of the needs of families with
    unemployed workers. We created a special Federal program that
    will provide $24 billion in special extended benefits to 8
    million workers through March 2004. We provided $8 billion more
    to States to assist the unemployed, which has helped to keep
    payroll taxes down in 30 States. The President recently signed
    the Jobs and Growth Tax Relief Reconciliation Act of 2003 (P.L.
    108-27), which includes another $20 billion that States can use
    for struggling families. So, we have helped millions of
    workers, while taking steps to strengthen the economy and
    create more jobs--which is what workers really want.
        The issue before us today is a threat to the Nation's
    unemployment benefit system. At issue is whether some employers
    wrongly minimize, or even avoid, paying their proper share of
    State unemployment taxes. In program jargon, this practice is
    known as State Unemployment Tax Acts (SUTA) (Social Security
    Act, 1935, 49 Stat. 620) dumping--SUTA should prevent this
    practice, but apparently doesn't in many cases.
        We will hear about several schemes which share a common
    thread. They all seek to thwart a basic purpose of the Nation's
    unemployment program since the 1930s--that employer taxes
    should be based on the experience of their employees in
    collecting unemployment benefits. In short, if an employer lays
    off lots of workers, that employer is supposed to pay more
    taxes to support unemployment benefits than an employer who
    rarely or never lays off workers. As we will hear today, that
    longstanding role is under attack by some employers attempting
    to dump their costs onto others.
        There is no better time to review this issue. Now, more
    than ever, the Nation's unemployment system needs to be working
    at maximum efficiency to provide benefits to workers. There are
    a number of reasons for Federal attention. One key Federal role
    is to ensure that this program is working efficiently and
    fairly. We are also concerned about the solvency of State trust
    funds, and the need for Federal loans for some States to pay
    benefits.
        I believe that SUTA dumping could quickly undermine program
    solvency. That could lead to higher payroll taxes for all
    employers, threatening our economic growth and job creation.
    Our oversight responsibilities merit a close look at this
    issue, and any appropriate responses. At this hearing today, we
    will hear from the U.S. Department of Labor, the U.S. General
    Accounting Office (GAO), a State that has recently taken steps
    to prevent SUTA dumping, and an employer who will tell us of
    the risk this practice poses for legitimate businesses. I look
    forward to all the testimony we will receive. Without
    objection, each Member will have the opportunity to submit a
    written statement and have it included in the record at this
    point. Mr. Cardin, would you like to make an opening statement?
        [The opening statements of Chairman Herger and Mr. Pomeroy
    follow:]
    Opening Statement of the Honorable Wally Herger, Chairman, Subcommittee
    on Human Resources, and a Representative in Congress from the State of
                                   California
        Good afternoon and welcome to today's joint hearing on unemployment
    fraud and abuse. It is a pleasure to be here with Chairman Houghton and
    other Oversight Subcommittee Members.
        This Congress is very aware of the needs of families with
    unemployed workers. We created a special Federal program that will
    provide $24 billion in temporary extended benefits to 8 million workers
    through March 2004. We provided $8 billion more to States to assist the
    unemployed, which has helped keep payroll taxes down in 30 States.
        The President recently signed the Jobs and Growth Tax Bill, which
    includes another $20 billion that States can use for struggling
    families. We have helped millions of workers, while taking steps to
    strengthen the economy and create more jobs, which is what workers
    really want.
        The issue before us today is a threat to the Nation's unemployment
    benefits system. At issue is whether some employers wrongly minimize or
    even avoid paying their proper share of State unemployment taxes. In
    program jargon, this practice is known as ``SUTA dumping,'' for State
    Unemployment Tax Acts that should prevent this practice, but apparently
    don't in many cases.
        We will hear about several schemes, which share a common thread.
    They all seek to thwart a basic purpose of the Nation's unemployment
    program since the 1930s--that employer taxes should be based on the
    experience of their employees in collecting unemployment benefits.
        In short, if an employer lays off lots of workers, that employer is
    supposed to pay more taxes to support unemployment benefits than an
    employer who rarely or never lays off workers. As we will hear today,
    that longstanding rule is under attack by some employers attempting to
    dump their costs onto others.
        There is no better time to review this issue than now. Now more
    than ever the Nation's unemployment system needs to be working at
    maximum efficiency to provide benefits to workers. There are a number
    of reasons for Federal attention. One key Federal role is to ensure
    this program is working efficiently and fairly. We also are concerned
    about the solvency of State trust funds, and the need for Federal loans
    for some States to pay benefits.
        SUTA dumping could quickly undermine program solvency. That could
    lead to higher payroll taxes for all employers, threatening economic
    growth and job creation. Our oversight responsibilities merit a close
    look at this issue and any appropriate responses.
        At this hearing today, we'll hear from the U.S. Department of
    Labor, the General Accounting Office, a State that has recently taken
    steps to prevent SUTA dumping, and an employer who will tell us of the
    risks this practice poses for legitimate businesses.
        I look forward to all the testimony we will receive.

     Opening Statement of the Honorable Earl Pomeroy, a Representative in
                    Congress from the State of North Dakota
        I am pleased that the Ways and Means Oversight Subcommittee is
    joining the Human Resources Subcommittee to examine an issue of mutual
    interest and concern. Today's hearing deals with our Federal-State
    Unemployment Compensation (UC) program and alarming reports of fraud
    and abuse by employers.
        Briefly, the UC program provides cash benefits to laid-off workers
    while they are actively seeking new employment. Their benefits are
    funded by employers who pay State UC taxes into State unemployment
    trust funds. Employers' tax payments are determined, in part, by a
    company's ``experience rating.'' Companies that have fewer employees
    drawing UC benefits will have lower tax rates than companies that
    routinely lay off workers.
        Unfortunately, many employers are engaging in activities to
    artificially and fraudulently reduce their State UC taxes. The
    Department of Labor and General Accounting Office recently have
    reviewed this abuse and determined that ``SUTA dumping'' is a serious
    problem for States. When employers fail to pay their fair share of UC
    taxes, States lose millions of dollars. This could result in increased
    tax rates for all employers.
        According to a recent GAO survey, approximately three-fifths of
    States believe that their own laws are insufficient to combat this
    abuse and that their enforcement efforts are inadequate. Further,
    fourteen States recently have identified specific ``SUTA dumping''
    employers who created losses to the their States of more than $120
    million.
        I want to thank Human Resource Chairman Herger and Ranking Member
    Cardin for bringing this issue to our subcommittees' attention. As
    always, I particularly want to commend Oversight Subcommittee Chairman
    Houghton for his leadership on this and other important matters facing
    our Country.

        Mr. CARDIN. Well, thank you very much, Mr. Chairman. First,
    let me start off by commending both you and Chairman Houghton
    for holding this joint hearing of the Subcommittee on Human
    Resources and the Subcommittee on Oversight of the Committee on
    Ways and Means, to take a look at one of our principal
    responsibilities--to make sure that the unemployment
    compensation system is working in our various States. One of
    the things we need to be careful about, is those people who are
    not playing according to the rules. It is not fair to the
    employers who are doing what is right.
        As you point out, this SUTA dumping results in companies
    trying to reduce their premium for unemployment insurance (UI)
    at the expense of either the solvency of the State fund, or at
    the expense of other employers who are required to pay higher
    premiums as a result of the SUTA dumping. In either case, that
    is not right. Our Committee has the responsibility to make sure
    that the laws are being complied with, and that we don't have
    these shell companies set up in order to reduce the rates for
    companies.
        I understand that the Department of Labor will be
    testifying. Mr. Bishop, we look forward to your testimony. You
    may be offering some suggestions in this area, and I think that
    will be very helpful to us in our work. In this context,
    though, let me mention one additional problem, Mr. Chairman--
    or, Joint Chairmen--that I think we should take a look at. That
    is, the companies that avoid paying any of the unemployment
    taxes. They do that by classifying people as independent
    contractors when, in fact, they are employees in many cases.
    These are cases where a person controls the actions of other
    individuals, as traditional employment would indicate, but are
    classified as an independent contractor in order to avoid, not
    only paying the UI taxes, but the other payroll taxes as well.
        The Department of Labor, 3 years ago, suggested that 80,000
    workers may be denied unemployment benefits every year because
    they are misclassified as independent contractors--80,000 a
    year. With SUTA dumping, as tragic as it is, normally, it
    doesn't deny people benefits; it affects the way employers pay
    into the fund. That is very serious, but in this case, 80,000
    people, in fact, are denied from receiving any of their
    benefits.
        So, I would urge this Committee, as we take a look at what
    is happening on SUTA dumping, expand our review to also look at
    the independent contractor issues and other issues that might
    be denying people benefits that they are otherwise entitled to,
    or adversely affecting those companies that are trying to play
    according to the rules. I look forward to hearing from all of
    our witnesses, and working with my fellow Members of the
    Committee.
        [The opening statement of Mr. Cardin follows:]
    Opening Statement of the Honorable Benjamin L. Cardin, a Representative
                     in Congress from the State of Maryland
        Mr. Chairman, let me start by commending you and Chairman Houghton
    for conducting this joint hearing on fraudulent practices used by some
    employers to evade their fair share of unemployment insurance taxes.
    Overseeing the administration and implementation of programs within our
    jurisdiction is an important responsibility for this committee.
        Unemployment compensation for laid-off workers is funded through
    payroll taxes paid by employers to State unemployment trust funds.
    These assessments are based on the number of workers who file for
    benefits, meaning businesses who lay off more employees have higher tax
    rates. Some employers manipulate this system of experience rating by
    transferring employees into shell companies formed solely for the
    purpose of evading unemployment taxes.
        This practice reduces the solvency of the States' unemployment
    trust funds, and it ultimately shifts more of the tax burden to
    responsible employers who play by the rules.
        I understand the Department of Labor (DOL) may provide us with
    specific statutory recommendations to prevent this type of fraud, known
    as SUTA dumping. I look forward to examining DOL's suggested language
    and to working with the agency and my colleagues on this committee to
    ensure all employers contribute their fair share to the unemployment
    system.
        In that context, it is worth mentioning there are other methods
    used by companies to avoid paying unemployment taxes.
        For example, some employers misclassify certain workers as
    independent contractors--a step which denies the worker many benefits,
    including unemployment compensation. A study commissioned by the
    Department of Labor three years ago suggested that 80,000 workers may
    be denied unemployment benefits every year because they are
    misclassified as independent contractors.
        In some ways this issue of misclassification may be an even greater
    problem than SUTA dumping because it deters workers from collecting
    unemployment benefits when they are laid-off.
        While some complexities surround the definition of an independent
    contractor, I hope DOL will provide this committee with recommendations
    to prevent the intentional misclassification of employees as
    independent contractors.
        If a business exerts control over how, when and where an individual
    conducts their work, but classifies them as an independent contractor
    for the purpose of avoiding UI taxes, that is wrong and it should be
    stopped. I look forward to hearing from our witnesses on this and other
    forms of fraud. Thank you.

        Chairman HERGER. Thank you, Mr. Cardin. Chairman Houghton
    of the Subcommittee on Oversight, would you like to make an
    opening statement?
        Chairman HOUGHTON. I would, thank you very much. Thank you
    for letting us be here. We on the Subcommittee on Oversight are
    honored to be associated with those of you on the Subcommittee
    on Human Resources--although we are slightly outnumbered at
    this time. The topic today, of course, is a review of the
    practices that may result in abuses of the unemployment
    compensation program. Chairman Herger has outlined some of the
    key principles of the unemployment compensation system, which
    is administered jointly by the Federal and State governments.
        As Members of the Subcommittee on Oversight, our interest,
    really, is in preventing any abuse of the program. I happen to
    believe that congressional oversight is critical to the
    integrity of it. So, I would like to yield to my associate, Mr.
    Portman, for any comments. I thank you very much for holding
    this hearing, and I am honored to be a Co-Chair with you.
        Mr. PORTMAN. I thank the Chair. I have no further comments
    to add to your good ones, except to thank the Subcommittee on
    Human Resources for joining with us in this important look. I
    think it is the first of the fraud and abuse Subcommittee on
    Oversight hearings we are going to be having. So, I look
    forward to hearing from the witnesses, and dealing with the
    particular issue of SUTA dumping. I thank the Chair for
    yielding to me.
        Chairman HERGER. Thank you. Before we move on to our
    testimony, I want to remind our witnesses to limit their oral
    statements to 5 minutes. However, without objection, all the
    written testimony will be made a part of the permanent record.
        Mr. KLECZKA. Mr. Chairman.
        Chairman HERGER. Yes.
        Mr. KLECZKA. As the only other Member who hasn't spoken,
    also, as the Ranking Member on the Subcommittee on Oversight, I
    want to join my Chairman, Mr. Houghton, by saying how thrilled
    we are to be here with you. Listening to the opening remarks, I
    must say, I was not aware of the problem, so I look forward to
    the testimony of Mr. Bishop, and others, to indicate what is
    going on in the field. I do want to associate myself with the
    remarks made by Mr. Cardin as they relate to independent
    contractors. Not only are they affected, or ill-affected, by
    the unemployment compensation dumping that we are going to hear
    about, but also by misclassifying these employees as
    independent contractors. We know that they lose out on other
    benefits, the major one of which is the Federal Insurance
    Contributions Act (FICA) (Social Security Act, 1935, 49 Stat.
    620)--the Social Security match from the employer. Mr. Houghton
    and I introduced legislation a session or two ago that would
    redefine what an independent contractor is. We have not done so
    again this session. To the folks here from the Department of
    Labor, that is a problem that is growing, and one of these days
    we are going to have to look at that, also. So, Mr. Chairman,
    thank you very much.
        Chairman HERGER. Thank you, Mr. Kleczka. Our first witness
    today is representing the Administration. I am pleased to
    welcome Mr. Mason Bishop, Deputy Assistant Secretary of the
    Employment and Training Administration, at the Department of
    Labor. Mr. Bishop.

       STATEMENT OF THE HONORABLE MASON BISHOP, DEPUTY ASSISTANT
        SECRETARY, EMPLOYMENT AND TRAINING ADMINISTRATION, U.S.
                          DEPARTMENT OF LABOR

        Mr. BISHOP. Thank you, Chairman Herger, Chairman Houghton,
    and distinguished Members of the Subcommittees. Thank you for
    inviting me to testify today. I am extremely pleased to have
    the opportunity to discuss options for closing a loophole in
    many State UI laws that permit some employers to pay less than
    their fair share of State unemployment taxes.
        Most unemployment benefits are financed by employer-paid,
    State unemployment taxes. An employer's tax rate is determined
    in accordance with the Federal Unemployment Tax Act (FUTA)
    (1954, 68A Stat. 439), which requires that each employer's tax
    rate be related to its experience with respect to unemployment,
    as measured by the UI benefits paid to its former workers. Each
    employer has an account within the State's unemployment fund
    which is charged for the benefits paid when a former worker
    collects UI benefits. The more charges to the account, the
    higher the tax rate--up to a maximum set by State law.
    Conversely, if the employer has a stable work force with few
    layoffs, the charges in tax rate are low.
        This tax determination system is known as experience
    rating. A new employer, who does not yet have sufficient
    experience to qualify for a rate based on experience, is
    assigned a beginning tax rate, referred to as a new employer
    rate. Experience rating has been an important part of the
    Federal-State UI system since its enactment in 1935. Experience
    rating helps ensure an equitable distribution of costs among
    employers, based on an employer's experience with UI. It also
    encourages employers to stabilize their work force, and
    provides an incentive for an employer to contest claims when
    employees quit or are fired for cause, since the cost
    attributable to claims may affect the unemployment tax rate of
    the employer.
        Over the past several years, some employers have found ways
    to manipulate experience ratings so that they pay lower State
    UI taxes than they would based on their UI benefit experience.
    This abuse of practice is commonly called SUTA dumping, and can
    deprive States of the revenues they need to provide workers the
    unemployment benefits to which they are entitled under State
    law. As you know, we are good with acronyms, and SUTA refers to
    the State Unemployment Tax Acts.
        Briefly, SUTA dumping generally occurs in two ways. First,
    the situation concerns employers setting up a shell company,
    and then transferring some or all of their payroll to the shell
    company to get a lower State unemployment tax rate. We believe
    that when an employer transfers its payroll to another employer
    with the same ownership and management, the experience of the
    transferred business activity should also be transferred to the
    acquiring employer.
        The second situation involves new owners avoiding new
    employer rates. We believe that this type of abuse should be
    addressed by prohibiting experience transfers to the new owner
    if the State agency finds that a business was acquired solely
    or primarily for the purpose of the new owner obtaining a lower
    rate of contributions.
        Through a Department of Labor-funded study issued in 1996,
    and an Inspector General final audit report issued in 1998, we
    have learned that SUTA dumping had occurred in some parts of
    the employee leasing industry and could be expanded into other
    industries. Subsequently, we learned that consulting firms
    actively market SUTA dumping to various industries with high UI
    costs as a way of reducing taxes and increasing profits.
        The act of SUTA dumping can deprive the State's
    unemployment fund of revenues, and will shift some benefit
    costs to other employers. We believe that those most affected
    by cost shifting are smaller employers who have neither the
    expertise nor the resources to set up such schemes, and
    employers with low UI costs who have no need to participate in
    these schemes.
        To address this serious issue, the Department of Labor has
    issued guides advising States of SUTA dumping, and alerting
    them to provisions enacted by some State legislatures that
    eliminate or reduce its practice. We were pleased to learn that
    North Carolina paid careful attention to this matter, and
    enacted legislation that clarified that an employer cannot
    avoid its earned experience rating by shifting its employees to
    a shell company that enjoys a lower UI tax rate. The witness
    from North Carolina can provide details on their specific
    action.
        The Administration is reviewing legislative remedies that
    would curb the practice of SUTA dumping, such as amending the
    FUTA to provide for the required or prohibited transfers
    previously discussed, along with penalties for willful
    circumvention. Any legislative remedies should be crafted in a
    way that minimizes the impact on legitimate business mergers,
    acquisitions, and reorganizations--and on current State law.
        In summation, manipulation of State tax rates is of great
    concern to the Department of Labor, and we are willing to work
    with this Committee to curb this practice. This concludes my
    remarks, and I will be glad to answer any questions you may
    have.
        [The prepared statement of Mr. Bishop follows:]
     Statement of the Honorable Mason Bishop, Deputy Assistant Secretary,
        Employment and Training Administration, U.S. Department of Labor
        Good Afternoon, Chairmen Herger and Houghton and distinguished
    members of the Subcommittees. Thank you for inviting me to testify. I
    am extremely pleased to have the opportunity to discuss options for
    closing a loophole in many state unemployment insurance (UI) laws that
    permits some employers to pay less than their fair share of state
    unemployment taxes. As you know, the Administration is concerned that
    the administrative structure of the unemployment insurance system is an
    unwieldy relic. In both the 2003 and 2004 budgets, we have proposed a
    comprehensive package of reforms to respond to demands from employers,
    workers, and states, which have clamored for change for the past
    decade.
                                   BACKGROUND
        Most unemployment benefits are financed by employer-paid state
    unemployment taxes. All states currently determine an employer's tax
    rate in accordance with the requirements of Chapter 23 of the Internal
    Revenue Code of 1986 (commonly referred to as the Federal Unemployment
    Tax Act or ``FUTA''). This statute requires that each employer's tax
    rate be related to its ``experience with respect to unemployment,''
    which is usually measured by the UI benefits paid to its former
    workers. Each employer has an account within the state's unemployment
    fund. In general, when a worker collects UI benefits, the former
    employer's account is charged for the benefits paid. The more charges
    to the account, the higher the tax rate, up to a maximum set by state
    law. If the employer has a stable workforce with few layoffs, the
    charges and tax rate are low. Employers with higher turnover generally
    pay higher taxes. This tax determination system is known as
    ``experience rating.'' A new employer who does not yet have sufficient
    experience to qualify for a rate based on experience is assigned a
    beginning tax rate, referred to as a ``new employer rate.''
        Experience rating has been an important part of the federal-state
    UI system since its enactment in 1935. The allocation of unemployment
    benefit costs through experience rating incorporates these benefits as
    a cost of business borne by employers. States have a great deal of
    latitude in deciding what percentage of their benefit costs will be
    experience-rated and what percentage will not be assigned strictly to
    individual employers, but will be shared by the state's employers as a
    whole. Experience rating helps ensure an equitable distribution of
    costs among employers based on an employer's experience with UI. It
    also encourages employers to stabilize their workforce and provides an
    incentive for an employer to contest claims when employees quit or are
    fired for cause, since the cost attributable to claims may affect the
    unemployment tax rate of the employer.
        However, over the past several years, some employers have found
    ways to manipulate experience rating so that they pay lower state UI
    taxes than they should based on their UI benefit experience. This
    abusive practice is commonly called ``SUTA dumping,'' and it can
    deprive states of the revenues they need to provide workers the
    unemployment benefits to which they are entitled under state law.
    (``SUTA'' refers to state unemployment tax acts.)
        SUTA dumping generally occurs in two ways. First, some employers
    escape poor experience (and high tax rates) by setting up a shell
    company and then transferring some, or all, of their payroll to the
    shell company after it has operated for several years with low turnover
    and earned a low tax rate based on that experience. As a result, in
    situations where there has been no change in ownership or management
    and no change in the business activity that would justify a reduced tax
    rate, the poor experience is ``dumped'' through the use of the shell
    company that has been assigned a lower state unemployment tax rate. We
    believe that when an employer transfers its payroll to another employer
    with the same ownership and management, the experience attributable to
    the transferred business activity should be transferred to the
    acquiring employer. This transfer would assure that employers do not
    set up shell companies to avoid their liability for UI taxes because
    the shell company would absorb the prior UI experience, as well as the
    business activity itself.
        In the second case, a small employer that has a low UI tax rate is
    bought by a person who does not currently employ any workers. The new
    owner ceases the business activity of the small employer and commences
    a different type of business. For example, a person who is not an
    employer buys a small flower shop that has a low UI tax rate. The new
    owner subsequently stops doing business as a flower shop and begins a
    temporary staffing business, while keeping the lower UI tax rate earned
    by the flower shop. The result is that the new owner avoids the rate
    normally assigned to new employers and receives the flower shop's lower
    tax rate. We believe that this type of abuse should be addressed by
    prohibiting experience transfers to the new owner if the state agency
    finds that a business was acquired solely or primarily for the purpose
    of obtaining a lower rate of contributions. However, states should be
    free to establish their own criteria for making such a finding that the
    acquisition was for the purpose of obtaining a lower rate of
    contributions. States that currently prohibit the transfer of
    experience in this situation generally look to whether the new owner
    continues the same business activity in determining if the acquisition
    was for the purpose of obtaining a lower rate of contributions.
    Following the same example, if a flower shop is acquired, the new owner
    must continue to operate the flower shop in order to obtain a UI tax
    rate based on the flower shop's UI experience.
        Through a Department-funded study issued in 1996 and an OIG Final
    Audit Report issued in 1998, we learned that SUTA dumping had occurred
    in some parts of the employee leasing industry and could be expanded
    into other industries. We have since learned that consulting firms
    actively market SUTA dumping to various industries with high UI costs
    as a way of reducing taxes and increasing profits. Some employers feel
    pressured to participate in this manipulation to avoid being put at a
    competitive disadvantage.
        SUTA dumping can deprive the state's unemployment fund of revenues
    and will shift some benefit costs to other employers. We believe that
    those most affected by cost shifting are smaller employers who have
    neither the expertise nor the resources to set up such schemes, and
    employers with low UI costs who have no need to participate in these
    schemes.
                              DEPARTMENTAL ACTIONS
        To address this serious issue, the Department of Labor's Employment
    and Training Administration has issued guidance advising states of SUTA
    dumping and alerting them to provisions enacted by some state
    legislatures that eliminate or reduce the practice of SUTA dumping. We
    were pleased to learn that North Carolina paid careful attention to
    this matter and enacted legislation that clarified that an employer
    cannot avoid a UI tax rate based on the previous experience of the
    employer in the UI system by simply shifting its employees to a shell
    company that enjoys a lower UI tax rate. North Carolina's legislation
    also raised the penalty for evading UI taxes from a misdemeanor to a
    felony. I will defer to the witness from North Carolina to provide the
    details of the state's actions.
        In addition, the Administration is reviewing legislative remedies
    that would curb the practice of SUTA dumping. Our remedy under
    consideration would amend FUTA to provide for the required and
    prohibited transfers previously discussed. Such a provision would
    result in millions per year in UI taxes being paid by the employers
    responsible for the costs rather than have those costs shifted to other
    employers.
        This remedy could also authorize the Secretary to draft regulations
    to address any methods of SUTA dumping not already discussed. This
    approach would aim to discourage employers from devising new tax
    avoidance schemes or loopholes since the Secretary would be authorized
    to close them. Finally, the remedy could require the states to impose a
    penalty on any person who willfully circumvents those provisions of
    state laws implementing the above amendments to FUTA, including
    financial advisors who may offer advice leading to willful
    circumvention. The intent behind these penalties would be to encourage
    compliance. States would be free to determine the penalties for
    violations of their laws, which could take the form of fines, increased
    state UI tax rates, loss of relevant licenses, and even jail for
    egregious violations.
        The Administration strongly believes that no new requirements
    should be imposed on states unless there is a compelling need. Any
    legislative remedy should be crafted in a way that minimizes the impact
    on legitimate business mergers, acquisitions and reorganizations, and
    on current state law. States should not be required to completely
    overhaul their provisions on transfers of experience in order to
    eliminate this abuse by a relatively small number of employers.
                                   CONCLUSION
        In sum, manipulation of state tax rates is of great concern to the
    Department and we look forward to working with the Committee on this
    issue. SUTA dumping can have a negative impact on state unemployment
    funds by forcing all employers to pay more UI taxes to compensate for
    the revenue lost as a result of the few who avoided taxes. To maintain
    the integrity of their experience rating systems and unemployment
    funds, states should enact legislation to deter UI tax rate
    manipulation schemes, and they should ensure such schemes are detected
    early and immediately corrected.
        This concludes my remarks. I will be glad to answer any questions
    you may have. Thank you.

        Chairman HERGER. Thank you, Mr. Bishop, for your testimony.
    I now will turn to questions. I would like to remind the
    Members that they each have 5 minutes for witness questions.
    Chairman Houghton, would you like to inquire?
        Chairman HOUGHTON. Well, the question that was just going
    through my mind is that, with all the good intentions here--the
    SUTA dumping could continue through some sort of substance
    behind it, behind whatever the activity was. Would you like to
    comment on that?
        Mr. BISHOP. Excuse me--I am not sure I understand.
        Chairman HOUGHTON. Well, one company, it says here in this
    piece of paper I have in front of me, suggested moving your
    employees on paper into another type of organization to assume
    a better rate--and that it more or less becomes a kind of shell
    game. Another company said that such activity was legal if
    there was some kind of a substance behind it. Would you like to
    comment on that?
        Mr. BISHOP. Sure. Essentially, what we are targeting here,
    Mr. Chairman, is when a company specifically sets up a shell
    company for the express purpose of trying to lower their
    experience rating--specifically to pay lower unemployment taxes
    at the State level. That is what we are targeting. If a company
    has a legitimate business merger, we would not want any
    legislation to impact that legitimate business merger. What we
    are seeing now--a phenomenon that seems to be occurring more
    and more--is the opportunity of companies to set up specific
    shell corporations with the express intent to shift their
    experience rating to a lower rating.
        Chairman HOUGHTON. If I want to set up a shell company, I
    am not going to say I am just setting up a shell company in
    order to move the employees around. I am going to have some set
    of reasonings behind it. Who is going to be making that
    judgment?
        Mr. BISHOP. Well, the State UI agency would be primarily
    involved, because they are the ones that are administering the
    State UI laws at the State level. So, in North Carolina, it
    would be the Employment Security Department; in other States,
    it would be whatever agency that does the UI program. They
    would have to make that individual determination based on
    whatever Federal law or State law that are in effect, as well
    as any guidance in the Department of Labor.
        Chairman HOUGHTON. They are not capable of doing that now?
        Mr. BISHOP. Well, right now the problem is that not all
    States, in a consistent fashion, have set up State laws that
    prohibit this activity. So, there are loopholes that,
    essentially, are being used to lower the experience rating. So,
    it is very inconsistent.
        Chairman HOUGHTON. Even in States that have set up a
    mechanism?
        Mr. BISHOP. Well, States like North Carolina, which you
    will hear from later today, have specifically taken steps in
    their State law to prohibit this practice and assure that those
    business mergers that occur are legitimately done, and not with
    the express intent to shift experience rating to a lower rate.
        Chairman HOUGHTON. Thank you very much.
        Chairman HERGER. Thank you. The gentleman from Maryland,
    Mr. Cardin, to inquire.
        Mr. CARDIN. Thank you, Mr. Chairman. Mr. Bishop, do you
    know when we might expect specific recommendations from the
    Administration to deal with this subject?
        Mr. BISHOP. Yes, Mr. Cardin. We have been working on
    potential legislation, been reviewing that, and would like to
    work with the Committee currently, regarding what we would like
    to do together to address this issue.
        Mr. CARDIN. Well, we always appreciate working with the
    Administration, but it is useful if we have specific
    recommendations. You have indicated two circumstances where you
    set up a shell company where the ownership is identical, or
    where you set up a transfer for the sole purpose, or the
    primary purpose, to reduce your experience rates. I think we
    all would agree, in those two circumstances, that we want to do
    something. So, I guess my question to you would be to give us
    some direction how--and I think this was Chairman Houghton's
    point. How could the Federal law be best crafted to encourage
    the States not only to take action in this area, but to take
    effective action in this area? These are two separate
    questions. I noticed that there are some States that have taken
    action, but we believe the enforcement is probably not there.
    So, I think guidance from you is going to be important to us.
    We want to work with you, but we need some specific guidance. I
    think only the Administration can at least get that started.
    So, we would appreciate something specific from you. Let me go
    to the second point that I mentioned in my opening statement.
    Well, first, before we leave the SUTA dumping, do you have any
    estimates as to how much might be involved here?
        Mr. BISHOP. Unfortunately, Mr. Cardin, we don't have any
    real solid data estimates at this time. This is something that
    became, as I mentioned in my testimony, aware to us as a
    merging practice in the mid-1990s. It is something that in the
    last couple of years seems to be practiced more often. We plan
    on working with the States to stay on top of it, and try to
    gather more evidence as to what is actually happening out there
    from a specific data set.
        Mr. CARDIN. In the next panel, GAO will report that 14
    States have been surveyed, and about $120 million has been
    found. Do you have any reason to believe that that is not
    within the ball park of what we are talking about?
        Mr. BISHOP. I think we would have every reason to believe
    that is, potentially, in the ball park.
        Mr. CARDIN. Thank you. The last issue I'd like to address,
    is the one I mentioned during my opening comments about other
    areas where there is fraudulent action within the unemployment
    system, particularly dealing with independent contractors.
    There is obviously a financial advantage for a company to
    classify a worker as an independent contractor far beyond the
    unemployment compensation system. Is the Department of Labor
    looking at this issue to try to give some guidance to Congress
    so, again, those companies that are doing it right are not
    being over penalized by those companies that are taking or
    doing things that are not permitted under law?
        Mr. BISHOP. Mr. Cardin, at this point we have not
    specifically issued any reports regarding this particular issue
    in the last few months. We would be more than willing to work
    with this Committee in looking at this issue and moving it
    forward if something needs to be done. I think it is a
    reasonable question to ask: what is the relationship of
    independent contractors within the context of the UI system,
    what are those impacts, and what does that mean? So, we would
    be more than willing to work with you on that.
        Mr. CARDIN. Well, I very much appreciate your offer. We
    will certainly be back to you so that we can try to find some
    information in this area. Thank you, Mr. Chairman.
        Chairman HERGER. Thank you. The gentleman from Ohio, Mr.
    Portman, to inquire.
        Mr. PORTMAN. Thank you, Mr. Chairman. Mr. Bishop, thank you
    for your testimony and your work on this. I have sort of an
    elementary question. I know that we are going to have other
    testimony that will address this matter, but this is a
    partnership with the States and the Federal Government, that
    our Federal unemployment taxes--clearly we have a stake in
    this, because if there is dumping, that means we are not
    getting as much money into the Federal tax coffers. Is that
    correct?
        Mr. BISHOP. No, that is not correct, Mr. Portman. This is a
    State--again, we have a Federal tax that is collected for the
    purposes of administering the UI system.
        Mr. PORTMAN. Right.
        Mr. BISHOP. We have State taxes that are collected for the
    benefit side. We are talking about the State taxes now. It is
    employers who are paying less----
        Chairman HOUGHTON. Could I interrupt? Could you speak just
    a little bit louder?
        Mr. BISHOP. Yes, excuse me. I am sorry, Chairman Houghton.
    This is a State unemployment tax issue.
        Mr. PORTMAN. According to testimony that is coming up next,
    the State taxes are actually at the U.S. Department of the
    Treasury. Is that correct?
        Mr. BISHOP. Right. It is held at the----
        Mr. PORTMAN. What I am trying to find is the right nexus at
    the Federal level. An obvious question would be, why does there
    need to be any Federal law here? Some States, like North
    Carolina, have been more aggressive, passed strong legislation,
    and are actually enforcing those laws. Other States have passed
    legislation. Maybe their enforcement is a little lax. Some
    States have chosen not to pass legislation. Some of those
    States, based on your own survey, indicate that they think
    everything is fine in their State, even though they don't have
    legislation.
        So, my question to you would be, what is the Federal nexus
    here? Why would it be appropriate for us to have new Federal
    legislation in this issue? Is it something that really is more
    appropriately left up to the States, or should there be some
    Federal involvement?
        Mr. BISHOP. Well, as you know, in the UI system, that is
    one of the core questions on any issue that is brought up--is
    it best determined at a State level or at a Federal level? In
    this particular case, we believe the appropriate level is at
    the Federal level, because we believe that this is an issue of
    fraud and abuse of the UI system, and we believe that it is an
    appropriate role of the Federal Government to address issues of
    fraud and abuse across the UI system.
        Mr. PORTMAN. Since the Department of Labor has
    responsibility, overall, for administering the program and,
    therefore, has a responsibility to ensure that there is not
    fraud and abuse?
        Mr. BISHOP. Correct.
        Mr. PORTMAN. What would you recommend in terms of a Federal
    law which would mandate every State to enact legislation; or
    would you rather see a Federal law which deals with things like
    transfer--and I know one of the witnesses coming up is going to
    talk about that. For instance, when there is a merger or
    acquisition, there is a transfer of experience. What would you
    think the appropriate Federal legislation would say?
        Mr. BISHOP. What we are looking at with the context of
    Federal legislation, right now, would be language that would
    actually say something to the effect of, in the context of a
    transfer, it would be for business purposes. So, we would be
    looking at that kind of language at the Federal level to
    recommend--to assure that this kind of thing does not happen.
        Mr. PORTMAN. To avoid the sham company issue?
        Mr. BISHOP. Right.
        Mr. PORTMAN. Then, how would you address the other issues
    that you have raised? Let us talk about the transfer issue
    generally. That isn't a shell company or a sham company issue,
    is it?
        Mr. BISHOP. It is the new employer. It is a new employer
    who purchases an existing company that is unrelated to the
    business--that they are going to be engaging in for the express
    purpose of getting that employer's UI tax rate, so that they
    don't have to pay the new employer rate.
        Mr. PORTMAN. What would you recommend in terms of Federal
    legislation?
        Mr. BISHOP. What we would do would be to prohibit the
    transfer experience from an acquired employer to the purchaser,
    the new employer in those instances, where it is unrelated to
    the business of the new employer.
        Mr. PORTMAN. In all acquisitions or mergers?
        Mr. BISHOP. No. If you were a new employer, and you
    acquired an existing business that was in the same industry or
    same line of business you were going to be doing, that would be
    a legitimate kind of business acquisition. If I am starting an
    auto parts store as an independent business owner, I buy a
    flower shop, and I don't have anything to do with flowers
    anymore, I just take the experience rate of that company--under
    our proposal, that would not be allowed anymore.
        Mr. PORTMAN. Is your sense that most States know whether
    there is dumping or not? The Congressional Research Service
    study said that there is $53 billion being paid to over 10
    million claimants. Out of that amount, I think the number we
    had was $120 million out of the $53 billion maybe being dumped.
    That is based on your study, saying that 14 States identified
    that. Do you think it is a bigger problem than that--that there
    is in excess of 14 States? Ohio, as an example, my State,
    indicates that they don't believe they have a dumping problem.
    They are concerned about it because they don't want it to
    migrate to Ohio. Do you think that it is a bigger problem than
    you identified in those 14 States?
        Mr. BISHOP. Well, we think it is an emerging problem that
    has the potential to get very big. We have firms that are
    actively promoting, doing this kind of activity. We think the
    GAO study is in the ball park of where we are at currently, but
    this has the potential of turning into a much bigger issue.
        Mr. PORTMAN. From $10s of millions to billions?
        Mr. BISHOP. Potentially.
        Mr. PORTMAN. Thank you, Mr. Chairman.
        Chairman HERGER. Thank you. The gentleman from Michigan,
    Mr. Levin, to inquire.
        Mr. LEVIN. Thank you. Mr. Portman asked appropriately for
    the linkage here with the Federal role and the Federal
    Government. The monies based on experience rating are
    essentially usable by the States to pay unemployment
    compensation, right?
        Mr. BISHOP. Correct.
        Mr. LEVIN. If the States have less money than they need,
    then they can borrow from the Federal Government. Right?
        Mr. BISHOP. Correct.
        Mr. LEVIN. So, there is that additional linkage, is there
    not? Now, a number of States are borrowing from the funds in
    the federal trust funds. Right?
        Mr. BISHOP. Currently, we have three States in a borrowing
    status with a couple more about to borrow, it looks like.
        Mr. LEVIN. So, there is that nexus, is there not? I think
    there is--in terms of why there should be a Federal interest.
    Also, the amount of funds that the States have available also
    affect what they do about eligibility, for example, right?
        Mr. BISHOP. Well, they can make eligibility decisions based
    on how much money they have to pay out in benefits,
    potentially.
        Mr. LEVIN. Look at the question of extended benefits. They
    don't generally provide that, but that could also affect the
    issue of whether they are going to have any funds to extend
    benefits in terms of high unemployment. So, I think there is
    not only the issue of the integrity of the State funds--if you
    want to call them that--but there are these linkages to the
    Federal Government, and another reason I think for there to be
    concern and action. So, let me ask you this. Is it necessary
    that there be action? Don't you think it is important that
    there be action this year?
        Mr. BISHOP. Yes. I think that you will find that the
    Administration will be wanting to work with the Committee on
    moving something this year with regard to this particular
    issue.
        Mr. LEVIN. When you say working with the Committee, are you
    going to present some proposals to us?
        Mr. BISHOP. I think we plan on doing so, yes.
        Mr. LEVIN. When would they be forthcoming?
        Mr. BISHOP. Again, we have legislative language that we
    have been working on in the Department of Labor. We believe
    that we could present the Committee with legislative language
    in fairly short order.
        Mr. LEVIN. That is really necessary if we are going to act
    this year, right?
        Mr. BISHOP. Yes.
        Mr. LEVIN. It is June. It is almost July. Then we are not
    here in August. Then there is September. So, you would hope in
    short order to have some proposals here?
        Mr. BISHOP. Yes.
        Mr. LEVIN. Isn't it true that this is likely to be a
    continually growing problem?
        Mr. BISHOP. Well, as I indicated in the other gentleman's
    question, we are concerned that this is the kind of problem
    that has the potential to grow and get bigger.
        Mr. LEVIN. It tends to grow as there is economic
    difficulty?
        Mr. BISHOP. Well, we don't have data in the context of--
    does it seem to occur more during a recessionary period, or
    not? Anecdotally, one might assume that it has the potential to
    do so, as folks are looking at the State-level employers,
    potentially, for lower cost in the UI program.
        Mr. LEVIN. There is some evidence that this practice has
    been growing the last few years?
        Mr. BISHOP. Yes. As I said, in the mid-1990s, we had two
    studies where it was documented as a practice that was just
    starting. It seems to be a practice that is growing, and we
    have evidence of certain companies actually promoting the use
    of this as a way to lower employer taxes.
        Mr. LEVIN. That evidence has been publicized?
        Mr. BISHOP. It has been documented, yes. I believe there is
    newspaper articles that talk about it, and I think you will
    hear, later, some evidence of that happening.
        Mr. LEVIN. Thank you.
        Chairman HERGER. Thank you. Mr. Bishop, is the real problem
    with SUTA dumping a lack of State or Federal legislation, or is
    it broader, and include problems with detection and
    enforcement?
        Mr. BISHOP. Well, I think--and this got to a point that was
    made earlier--it really is a two-part issue, which I think you
    have just identified, Mr. Chairman. One of which is, we do
    believe that it is an issue of tightening the law to say that
    the practices are clearly not legal. Then, once we do that, it
    will be incumbent upon the Department of Labor to work very
    closely with the States to help them be able to put into effect
    the appropriate enforcement actions, and to be able to monitor
    and assure that the law is being met.
        Chairman HERGER. Thank you. Are there any State performance
    measures that indicate the number of SUTA dumping enforcement
    actions taken by States with existing legislation?
        Mr. BISHOP. No. We do not have performance measures on that
    currently. However, this may be something we need to take a
    look at.
        Chairman HERGER. Very good. Thank you. The gentleman from
    Wisconsin.
        Mr. KLECZKA. Thank you, Mr. Chairman. Just a very quick
    question, Mr. Bishop. Is this a problem that can only be fixed
    by the Federal Government, and by Federal legislation, or do
    the States have within their power the ability to respond to
    this dumping situation?
        Mr. BISHOP. Well, the States clearly could pass State
    legislation. You would have to have 53 State jurisdictions
    doing so. If all 53 UI jurisdictions--States and territories--
    did that, they could fix it on their own. Again, we believe
    that it is an appropriate role of the Federal Government.
        Mr. KLECZKA. To foster uniformity throughout the country?
        Mr. BISHOP. Yes, correct.
        Mr. KLECZKA. This is the place to come?
        Mr. BISHOP. Correct.
        Mr. KLECZKA. Okay, good. Thank you.
        Chairman HERGER. Thank you. Mr. Bishop, the Department of
    Labor's 2002 Unemployment Insurance Program Letter, UIPL 34-02,
    alerted States to expanded SUTA dumping activity. What prompted
    this action, and what response have you gotten from the States?
        Mr. BISHOP. Well, again, Mr. Chairman, what prompted the
    action was more evidence and anecdote concerning this becoming
    a growing problem. We felt it necessary to alert the States
    that this is something they need to look at, potentially, to
    get the ball rolling and legislate at the State level.
        What we have seen happen as a result, I think you are going
    to hear later today--a State like North Carolina, which has
    taken some action immediately. We have a couple of other
    States--Texas, Delaware, and California, for example--that have
    also taken some steps and some action to do that. So, we felt
    it was important to alert the States of this practice, and also
    to say that, in the context of what the Department of Labor
    feels, it is not an appropriate activity to continue to occur.
        Chairman HERGER. Thank you very much for your testimony,
    Mr. Bishop. With that, we call on our second panel today.
    Robert Cramer, Managing Director of the Office of Special
    Investigations at the GAO. He is accompanied by Paul
    Desaulniers, Senior Special Agent in the Office of Special
    Investigation at GAO. David Clegg, Deputy Chairman for
    Communications for the North Carolina Employment Security
    Commission in Raleigh, North Carolina. Carl Camden, President
    and Chief Operating Officer of Kelly Services, Inc., in Troy,
    Michigan. Thank you. Mr. Cramer, GAO.

      STATEMENT OF ROBERT J. CRAMER, MANAGING DIRECTOR, OFFICE OF
        SPECIAL INVESTIGATIONS, U.S. GENERAL ACCOUNTING OFFICE;
       ACCOMPANIED BY PAUL DESAULNIERS, SPECIAL AGENT, OFFICE OF
                         SPECIAL INVESTIGATIONS

        Mr. CRAMER. Good afternoon, Chairman Herger, Chairman
    Houghton, and Members of the Subcommittees. Thank you for the
    opportunity to appear before you today to discuss the results
    of the work that we have done pertaining to SUTA dumping. I am
    accompanied here today by Special Agent Paul Desaulniers, who
    is our Chief Investigator in this matter.
        To obtain an overview of the extent of the SUTA dumping
    problem, the Office of Special Investigations at GAO did two
    things. First, we conducted a nationwide survey of State UI
    administrators. Second, Agent Desaulniers, posing as a business
    owner who was looking for ways to reduce the State UI tax he
    pays for his employees, placed telephone calls to four tax
    planning consultants he identified through the Internet to
    determine whether and how they promote SUTA dumping techniques.
        To summarize our survey results, approximately two-fifths
    of the administrators indicated that their States are
    adequately addressing the problem, or that they are not aware
    of any SUTA dumping problems in their jurisdictions. However,
    approximately three-fifths of the State administrators informed
    us that their State laws are insufficient to deal with SUTA
    dumping problems, and that enforcement efforts to combat such
    practices are inadequate.
        Administrators in 21 States reported that they have no laws
    at all specifically addressing this SUTA dumping issue. The
    remaining 29 State administrators indicated that they do have
    laws; however, seven of those indicated that their laws are not
    sufficient.
        Additionally, more than half of the 50 administrators who
    responded to our survey indicated that SUTA dumping practices
    are or may be resulting in a loss of State unemployment tax
    revenue in their States. Fourteen States reported that they
    have identified SUTA dumping cases within the past 3 years with
    losses from these cases totaling $120 million.
        Many administrators added comments to our survey in which
    they noted that identifying and proving SUTA dumping is a time
    consuming and resource intensive process. They also cited poor
    detection methods and inadequate funding for investigation and
    enforcement efforts as obstacles to addressing the SUTA dumping
    issues.
        To determine whether and how consulting firms promote SUTA
    dumping methods, Agent Desaulniers placed telephone calls to
    four tax planning consultants. Again, he found these all
    through the Internet. He posed as a construction company owner
    having 1,000 employees and doing business in four different
    States. He asked each consultant about the feasibility of
    switching his employees to another business entity in order to
    reduce his UI tax payments.
        One consultant he spoke with recommended that he spin off
    part of his company and form a new one to obtain a lower tax
    rate. The consultant said that as long as the business has good
    strategies, and there is, quote, ``Some kind of substance
    behind it,'' the practice is legal. Another consultant
    suggested moving employees on paper into another type of
    organization to get a better tax rate. In his words, quote,
    ``It more or less becomes a kind of shell game where you are
    moving people around periodically to obtain more favorable
    rates.'' The consultant stated that this practice is legal. A
    third consultant told Agent Desaulniers that if he merely
    switches his employees to a newly created company, the State
    would transfer the unemployment tax rate of the old company to
    the new one. So, he suggested that, instead, one should lower
    the rate by merging the existing company with another business
    that has a lower tax rate.
        The fourth consultant we contacted stated that SUTA dumping
    is illegal in many States, but is permitted in some States if
    certain events occur, such as an asset transfer, or the
    formation of a new business division. This consultant was very
    cautious, however, about this type of strategy, and indicated
    little interest in providing SUTA dumping services. Mr.
    Chairman, that concludes my statement. At this time, Agent
    Desaulniers will play excerpts from the tapes of two
    conversations he had with the consultants. Appendix I to the
    testimony is a transcript of the excerpts he will be playing.
        Mr. DESAULNIERS. So, to reiterate, I posed as a
    construction company owner having 1,000 employees doing
    business in Maryland, Pennsylvania, Delaware, and New Jersey. I
    asked each consultant about ways to reduce my UI taxes, and the
    feasibility of switching employees to another business entity
    for that purpose. This is the first consultant I spoke with.
        [Tape played.]
        Mr. DESAULNIERS. Here is the second consultant that I spoke
    with.
        [Tape played.]
        Mr. DESAULNIERS. That concludes the conversations.
        Mr. CRAMER. That concludes our presentation. We would be
    happy to answer any questions that you might have.
        [The prepared statement of Mr. Cramer follows:]
      Statement of Robert J. Cramer, Managing Director, Office of Special
      Investigations, U.S. General Accounting Office, accompanied by Paul
     Desaulniers, Senior Special Agent, Office of Special Investigations,
                         U.S. General Accounting Office
        Mr. Chairman and Members of the Subcommittee:
        I am pleased to appear before you today to discuss the results of
    our investigation of the extent to which states have found that
    companies manipulate state unemployment tax rates through a variety of
    methods in order to lower their unemployment taxes, a practice known as
    ``SUTA dumping,'' and of the extent to which some consulting firms
    promote SUTA dumping methods.
        We conducted our investigation from March 2003 through June 2003 in
    accordance with quality standards for investigations as set forth by
    the President's Council on Integrity and Efficiency. To obtain an
    overview of the extent of the problem, we conducted a survey of
    unemployment insurance administrators, including the 50 states,
    District of Columbia, U.S. Virgin Islands and Puerto Rico.
    Additionally, one of our agents, posing as a business owner who was
    looking for ways to reduce state unemployment insurance taxes, placed
    telephone calls to four consulting firms we identified through the
    Internet to determine whether they promote SUTA dumping techniques. We
    also interviewed officials of the Office of Workforce Security,
    Department of Labor (DOL) to determine how the federal-state
    unemployment program operates.
        I am accompanied today by Special Agent Paul Desaulniers.
        In summary, approximately three-fifths of the state unemployment
    insurance administrators informed us that their state laws are
    insufficient to combat SUTA dumping and that enforcement efforts to
    combat such practices are inadequate. Many of the remaining
    administrators reported that their laws and enforcement efforts are
    sufficient to address the problem. Other administrators told us that
    they do not have, or are not aware of, SUTA dumping problems in their
    states. Additionally, we found that three of the four consulting firms
    we contacted were willing to assist us in developing SUTA dumping
    methods for our fictitious business. The fourth firm suggested that
    SUTA dumping methods are illegal in most states and indicated that they
    were reluctant to engage in this type of business.
    Background
        The federal-state unemployment insurance program, created in part
    by the Social Security Act of 1935, is administered under state law
    based on federal requirements. The Federal Government sets broad policy
    for administration of the program, monitors state performance, and
    provides technical assistance as necessary to the states. To finance
    the program, states collect unemployment insurance taxes from employers
    to supply the unemployment insurance trust fund. When employers
    underpay their taxes, states may compensate for these losses by
    increasing the tax rate for all employers. Therefore, companies that do
    not manipulate their tax rates by engaging in SUTA dumping practices
    may be effectively penalized by the SUTA dumping practices of companies
    that do. Currently, there is no federal mandate requiring states to
    promulgate laws to restrict employers from engaging in SUTA dumping
    practices.
        States use an ``experience rating'' system to assign tax rates to a
    business based on its history of unemployment insurance claims;
    generally a business with a large number of unemployment claims will
    have a high experience rating and a correspondingly high tax rate.
    Employers engage in SUTA dumping when they try to lower the amount of
    tax they pay by altering their experience ratings. Some employers lower
    their experience ratings using a variety of methods, which include the
    following, among others:

          Purchased shell transactions. Purchased shell
    transactions occur when a newly formed company purchases an existing
    business that has a low experience rating and, therefore, a lower tax
    rate than the newly formed company would have. Under some state laws
    dealing with employer succession, the existing business's low
    experience rating would be transferred to the newly formed company.
          Affiliated shell transactions. Affiliated shell
    transactions occur when an existing business with a high experience
    rating forms a number of additional corporations, transfers a small
    number of employees to those corporations, and pays unemployment taxes
    on their wages until the additional corporations earn a minimum tax
    rate. Subsequently, major portions of the original company's employees
    are moved to one or more of the new companies to take advantage of the
    lower unemployment tax rate, thereby ``dumping'' the original company's
    high tax rate.
    Survey Results
        To obtain an overview of the extent to which these and other SUTA
    dumping practices are used throughout the United States, we conducted a
    nationwide survey of state unemployment insurance
    administrators.[1] More than half of the 50 administrators
    who responded to our survey acknowledged that SUTA dumping practices
    are, or may be, resulting in a loss of state unemployment tax revenue.
    Fourteen states reported that they have identified specific SUTA
    dumping cases within the past 3 years, with losses from these cases
    exceeding $120 million. The employee leasing industry--followed by the
    hospitality and construction industries, respectively--was most often
    cited by administrators as engaging in SUTA dumping practices.
    ---------------------------------------------------------------------------
        \[1]\ We sent the survey to the unemployment insurance
    administrators in the 50 states, District of Columbia, Puerto Rico, and
    the U.S. Virgin Islands. Fifty administrators responded to the survey.
    ---------------------------------------------------------------------------
        Administrators in 21 states reported that they have no laws
    specifically addressing SUTA dumping practices. The remaining 29 state
    administrators indicated that they have laws addressing SUTA dumping,
    but 7 of them felt that those laws were inadequate. Approximately two-
    fifths of the administrators indicated that their states are adequately
    addressing the problem or that they do not know of any SUTA dumping in
    their states. Many administrators noted that identifying and proving
    SUTA dumping is a time-consuming and resource-intensive process. They
    also cited poor detection methods and inadequate funding for
    investigation and enforcement efforts as obstacles to addressing these
    practices.
        Administrators in 20 states reported that other state laws, often
    those dealing with employer succession, adequately address SUTA dumping
    practices. These states cite their employer succession laws as
    protection against such practices because they require the transfer of
    experience ratings from one company to a successor company when
    ownership or management is substantially the same. However, DOL advised
    us that no states currently have laws prohibiting companies from using
    partial transfers of experience rating as a SUTA dumping practice.
        The employee leasing industry provides contractor staff to client
    firms. The leasing company is usually responsible for the workers'
    wages and payroll taxes and may be considered their employer, even
    though work is performed at the client firm. Thus, the leasing agency,
    not the client firm, will acquire a higher experience rating if these
    workers claim unemployment benefits. Several states preclude this SUTA
    dumping practice by holding the client company responsible for
    unemployment insurance tax on the employees it leases. However, DOL
    told us that these laws do not preclude the client company from
    subsequently using other SUTA dumping practices, such as affiliated
    shell transactions, to lower its tax rate.
    Telephone Calls to Consultants
        In an effort to determine whether and how consulting firms promote
    SUTA dumping methods, one of our agents placed telephone calls to four
    firms. The agent posed as a construction company owner having
    approximately 1,000 employees and doing business in Maryland,
    Pennsylvania, Delaware, and New Jersey. He asked each firm contacted
    about the feasibility of switching employees to another business entity
    in order to reduce unemployment insurance taxes.
        One firm representative we spoke with recommended that we spin off
    part of our current company and form a new one to obtain lower
    unemployment insurance rates. He said that as long as we ``have good
    strategies'' and ``have some kind of substance behind it,'' this
    practice is perfectly legal.
        Another firm representative suggested ``moving your employees on
    paper into another type of organization to assume a better rate.'' He
    stated, ``It more or less becomes kind of a shell game where . . .
    you're moving people around periodically to obtain more favorable
    rates.'' The representative stated that this practice is legal but
    added, ``it becomes more of an ethical issue.''
        A third firm representative told us that if employees are simply
    switched to a newly created company, the state will transfer the
    experience rating of the old company to the new one unless you
    ``misrepresent your company.'' Instead, he suggested lowering the rate
    by merging with another company that has a better rate.
        The fourth firm representative we contacted stated that some people
    file for a new tax identification number and move all their employees
    on paper over to that new tax number to obtain a lower experience
    rating. The representative stated that this is illegal in many states
    but is allowable in others if some discernible event occurs, such as an
    asset transfer or formation of a new business division. The
    representative was very cautious about this type of strategy, however,
    and said, ``If you want that done, we're probably not your best
    company.''
        Mr. Chairman, this concludes my statement. At this time, Mr.
    Desaulniers will play excerpts from the tapes of two conversations he
    had with these consultants. (See app. I for these extracts.) We will
    then answer any questions that you or other members of the Subcommittee
    may have.
    Contacts and Acknowledgement
        For further information regarding this testimony, please contact
    Robert J. Cramer at (202) 512-7455 or Paul Desaulniers at (202) 512-
    7435. Individuals making contributions to this testimony included
    Jennifer Costello and Barbara Lewis.

                                     ______

        Chairman HERGER. Thank you very much. We will move to our
    next witness, Mr. David Clegg, Deputy Chairman for
    Communications for the North Carolina Employment Security
    Commission in Raleigh, North Carolina. Mr. Clegg.

       STATEMENT OF DAVID L. CLEGG, DEPUTY CHAIRMAN, EMPLOYMENT
     SECURITY COMMISSION OF NORTH CAROLINA, RALEIGH, NORTH CAROLINA

        Mr. CLEGG. Chairman Herger, thank you. Chairman Houghton,
    Members of the Subcommittees, thank you for providing me with
    the opportunity this afternoon to speak to you----
        Chairman HERGER. If you could move the microphone. There
    you go.
        Mr. CLEGG. To talk to you about the significance of State
    UI Trust Fund solvency. I am proud that North Carolina has
    taken a leadership role in identifying both statutory and
    programmatic remedies for this practice, which has the
    potential to hurt workers and employers who fulfill their roles
    in our economy in an honorable and legal manner.
        If SUTA dumping can exist in North Carolina, it surely must
    exist in every State. Due to a robust economy and a trust fund
    balance of over $1.6 billion, North Carolina was able to lower
    its UI rate for new accounts, and the tax rate for positive
    rated employers in 1993, 1994, 1995, 1996, and 2000. In 1995,
    our rate was reduced by 50 percent, and in 1996, all positive
    rated accounts received a zero tax rate. We boasted a labor
    market of over 4 million people and 178,000 employers.
        So, we know that SUTA dumping is present in North Carolina.
    The practice arrived contemporaneously with the downturn in
    North Carolina's economy, and in our dramatic rise in claims
    for UI assistance. We were told about it by employers shocked
    when they received literature telling them to do it. Members of
    the North Carolina General Assembly, whose constituents
    complained that they were being solicited, told us. We contend
    that SUTA dumping has always been illegal under North Carolina
    law, despite the bold statements of a few to the contrary.
    However, with the recent action of the North Carolina General
    Assembly, signed into law by Governor Easley, everyone now
    knows that it is illegal.
        We know that SUTA dumping tax shelter schemes have been
    sold to major corporations operating in North Carolina. We also
    know that this activity started in at least the third quarter
    of 2001.
        Initially, clear existence of SUTA dumping was uncovered
    when the Employment Security Commission received a late payment
    on a voluntary UI tax contribution in January 2002. A taxpayer
    had set up a limited liability corporation (LLC), transferred a
    tiny fraction of the company's negative experience rating to
    that LLC, and then the LLC planned to obtain a zero tax rate
    the next year by making a small voluntary contribution.
    Voluntary payments are allowed by statutes, and employers can
    use them to lower a UI tax rate. However, the payments have to
    be made on time.
        The parent corporation could have lowered its tax rate to
    zero, but the voluntary contribution would have been in excess
    of $4 million. By creating the LLC only with employees, the LLC
    needed only to pay $30,000 to obtain its new rate. The next
    year, the parent corporation would have reported wages of all
    of its over 1,500 workers to the LLC with the zero rate.
        The Employment Security Commission issued public statements
    and a public tax alert. We were aware of the issue through the
    Department of Labor program letter. Constituents alerted both
    Members of the General Assembly and the Employment Security
    Commission, and the General Assembly took quick action, which
    was a collaborative effort among legislators, the Employment
    Security Commission, certified public accounts, and employer
    associations.
        Our law became effective May 20th. It makes it a felony for
    any person to attempt to SUTA dump. The law is premised on a
    continuity of control issue, and carries its stiffest penalties
    against employers with more than 10 employees owing more than
    $2,000, and/or having a negative experience rating of more than
    $5,000. This law does clearly identify that there is an
    activity called UI contribution tax return preparer, and
    establishes liability for that illegal preparation also. The
    felonious components of that bill provide for incarceration
    from six to 8 months.
        It is too early to tell what our final dollar and liability
    amount will be for SUTA dumping. We recently advised an
    accounting firm that they had failed to reveal it in their
    independent audit. On other fronts, we have received an $18,000
    assessment. We have seen protests of over $400,000 be dropped.
    We have seen taxpayers reassume liability for over $4 million.
    In the next 30 days, we will begin on-site investigations at 10
    taxpayer offices where we have reason to believe this has
    occurred with liability of over $2 million.
        North Carolina has developed a real-time computerized tax
    analysis program that does assist us in detecting SUTA dumping.
    It looks at voluntary contribution rates, it looks at the
    movement of work forces, and it looks at issues of the lack of
    filing from corporate taxpayers. Thank you very much for this
    opportunity. I look forward to your questions.
        [The prepared statement of Mr. Clegg follows:]
       Statement of David L. Clegg, Deputy Chairman, Employment Security
             Commission of North Carolina, Raleigh, North Carolina
        Chairman Houghton and Chairman Herger, thank you for providing me
    with the opportunity to speak today about the issue of state
    unemployment insurance tax rate manipulation and its significance to
    state unemployment insurance trust fund solvency. I am proud that North
    Carolina has taken a leadership role in identifying both statutory and
    programmatic remedies for this practice that has the potential to hurt
    the workers and employers who fulfill their roles in our economy in an
    honorable and legal manner. At the North Carolina Employment Security
    Commission, we say that ESC stands for ``Economic Stability in the
    Community,'' and the existence of SUTA dumping potentially undermines
    ESC's mission of providing critically importance transitional
    assistance to workers discovering new career paths in a technologically
    sophisticated and diverse economy.
        If SUTA dumping can exist in North Carolina, it surely must exist
    in every state. Due to a robust economy and a trust fund balance of
    over $1.6 billion, North Carolina was able to lower its unemployment
    insurance (UI) rate for new accounts and the tax rate for positive
    rated employers in 1993, 1994, 1995, 1996 and 2000. In 1995, the rate
    was reduced by fifty percent, and in 1996 all positive rated accounts
    received a zero tax rate. North Carolina boasted a labor market of over
    4 million people and 178,000 employers. If SUTA dumping exists in this
    progressive economic climate, it must exist in less robust economies
    and in states with less attractive tax rate structures. Even today, as
    North Carolina's fifty percent UI tax rate discount is discontinued, it
    has the fourth lowest UI tax rate in the nation. (Exhibit 1)
        We know that SUTA dumping is present in North Carolina. The
    practice arrived contemporaneously with the downturn in North
    Carolina's economy and the dramatic rise in claims for UI assistance.
    (Exhibit 2) We were told about it by employers shocked when they
    received literature telling them to do it. Members of the North
    Carolina General Assembly whose constituents complained that they were
    being solicited told us. We contend that SUTA dumping has always has
    been illegal under North Carolina law despite the bold statements of a
    few to the contrary. With recent action by the North Carolina General
    Assembly as signed into law by Governor Easley, everyone now knows it
    is illegal. Millions of tax dollars are at risk through the use of
    unlawful UI tax schemes. We know that SUTA dumping tax shelter schemes
    have been sold to major corporations operating in North Carolina. This
    activity started, at least, in 2001.
        The Employment Security Commission of North Carolina (NCESC) levies
    and collects unemployment taxes, maintains wage records, processes
    benefit claims, and assigns tax charges to employer's accounts. NCESC
    issues over 200,000 initial decisions on benefit claims affecting
    claimants and employers. It holds over 40,000 hearings and has internal
    appeals procedures as well as continuous civil litigation. ESC has a
    statewide staff of 90 auditors who conduct forensic audits and often
    depend on criminal warrants against employers who fail to file tax
    returns. Ten years ago, the Commission adopted a system of employer
    self-application. One result of voluntary compliance was more time for
    auditors to conduct intense scrutiny of problem accounts.
        A key feature of UI law is that employers must pay the tax benefit
    costs for their own workforce. This is done by using the experience
    rating system in which an employer's tax account is charged for the
    costs of claims paid out to former employees--unemployed through no
    fault of their own.
        Basically, SUTA dumping occurs in the following fashion: A
    corporation, (First Corporation) decides its does not want to pay the
    high unemployment insurance taxes. Those high taxes were caused by the
    corporation's own history of high employee turnover and large
    unemployment claims. To avoid the tax, First Corporation sets up new
    corporation (Spin-off Corporation.)
        Spin-off Corporation files for a new UI account from NCESC. Spin-
    off Corporation claims to be a brand new employer entitled to a lower
    new employer UI tax rate. Spin-off Corporation does not disclose that
    First Corporation controls it. NCESC has no reason to assume that Spin-
    off Corporation is not a new taxpayer. In Spin-off Corporation's
    application for a new employer tax identification number, Spin-off
    Corporation does not admit that First Corporation controls it.
        Once Spin-off Corporation is established with NCESC, First
    Corporation waits until the next calendar quarter to shift the
    reporting of all its employees to Spin-off Corporation at the lower tax
    rate. First Corporation hopes that NCESC won't notice the pattern of
    transfer. First Corporation retains control of Spin-off Corporation. By
    retaining legal control or ownership of Spin-off Corporation, First
    Corporation maintains its common law employer-employee relationship
    with every employee whose wages were misreported.
        It is clear that First Corporation is entitled to establish any
    number of business entities it chooses. They can be partnerships, S
    corporations, or L.L.C.'s (Limited Liability Corporations). Those
    businesses can do anything legal, but they can't escape the fact that
    First Corporation has to pay UI taxes on all the employees that it
    controls. As long as First Corporation controls Spin-off Corporation,
    First Corporation retains the responsibility to pay UI taxes on its own
    workforce. Until First Corporation sells or releases control of Spin-
    off Corporation, First Corporation retains its tax liability.
        Several economic and financial measures confirm that First
    Corporation is the taxable employer as defined by North Carolina law.
    First Corporation's workforce is now performing the same work for Spin-
    off Corporation at the same locations. First Corporation has not sold
    or given up its benefit from and ultimate control of Spin-off
    Corporation's workers. First Corporation treats the revenue from Spin-
    off Corporation's workers and operations as its own. Spin-off
    Corporation's profits and losses are reported on First Corporation's
    income tax returns by treating Spin-off Corporation as a disregarded
    entity under IRS laws. First Corporation retains the legal right to
    control and benefit from Spin-off Corporation's profit and loss even if
    First Corporation does not directly exercise such rights. Spin-off
    Corporation may have the same corporate officers, physical facilities,
    payroll and human resources structure. Inaccurate, misleading and
    incomplete information was supplied to NCESC in order (1) to obtain a
    lower tax rate than allowed by law, (2) to pay a less tax than owed,
    and (3) to write off many dollars of accumulated tax liability.
        NCESC is fortunate to have a dedicated UI tax staff committed to
    full compliance under law. Initially, clear existence of SUTA dumping
    was uncovered when ESC received a late payment on a voluntary UI tax
    contribution in January 2002. A taxpayer had set up an L.L.C. and
    transferred a tiny fraction of the company's negative experience rating
    account to the L.L.C. The L.L.C. planned to obtain a zero tax rate for
    the next year by making a small voluntary UI tax payment. Voluntary
    payments are allowed by statute and employers can lower a UI tax rate
    by doing so. However, the payments have to be made on time. The parent
    corporation could have lowered its own tax rate to zero, but the
    voluntary contribution would have been nearly $4 million. By creating
    the L.L.C. with only a few employees and a tiny portion of the parent
    corporation's tax liability, the L.L.C. only needed to pay $30,000 to
    obtain the low rate. The next year, the parent corporation would have
    reported the wages of all its over 1,500 workers on the tax return of
    the L.C.C. with the zero tax rate.
        ESC issued public statements and a public tax alert about SUTA
    dumping. (Exhibit 3) Press releases and the Commission's own website
    (ncesc.com) were used to warn of the potential criminal liability for
    SUTA dumping. Major news outlets in North Carolina were conducting
    independent investigations of SUTA dumping based on the August, 2002
    (revised December, 2002) U.S. Department of Labor Program Letter and
    responded to NCESC's request to raise public awareness on this issue.
    Constituent concerns alerted members of the North Carolina General
    Assembly to the need for statutory action about SUTA dumping. The North
    Carolina SUTA dumping bill became a collaborative effort among
    legislators, ESC, and certified public account and employer
    associations.
        North Carolina's SUTA dumping bill became law on May 20, 2003.
    (Exhibit 4) The law makes it a felony for any person to attempt to SUTA
    dump or for a UI tax advisor to aid or abet SUTA dumping. The law is
    premised upon continuity of control and carries its stiffest penalties
    against employers with more than 10 employees, owing more than
    $2,000.00, and/or having a negative experience rating of more than
    $5,000.00. This law identifies that there is an activity called ``UI
    contribution tax return preparer'' and establishes liability for
    illegal preparation. The presumptive sentence for felonious violation
    of the law is 6 months incarceration up to 8 months for aggravated
    circumstances. Uncapped fines may be imposed in the discretion of the
    court. At the present time, the Commission is considering the
    possibility of joint investigations with nearby states that are
    victimized by multi-state SUTA dumping schemes.
        It is too early to tell what the final dollar and liability count
    will be for SUTA dumping. NCESC recently advised an accounting firm
    that it had failed to uncover SUTA dumping when it performed an
    independent audit. The evidence in that case shows SUTA dumping in
    November 2001. On other fronts, NCESC received an $18,000.00 assessment
    to cover a SUTA dump UI tax delinquency. Taxpayers have dropped
    protests seeking the return of over $400,000.00 in UI taxes. Other
    taxpayers have re-assumed tax liability of $4 million. Within the next
    30 days, NCESC will begin on-site investigations at 10 taxpayer's
    offices with UI tax liability of over $2 million. Inquiries arrive at
    NCESC nearly every day seeking to address this issue through
    negotiation and payment. NCESC has developed a real time, computerized,
    tax analysis program to detect SUTA dumping. It includes, in part, a
    revised voluntary contribution report that detects lowered rates beyond
    ordinary parameters, a management report charting the movement of work
    forces from overdrawn negative accounts to newly established positive
    accounts, and a management report that shows a lack of filing from
    corporate taxpayers.
        The vast majority of North Carolina's 178,000 employers is honest
    and willingly pays their taxes. A century ago a distinguished corporate
    lawyer became Secretary of War, then Secretary of State, and then an
    U.S. Senator. He said, ``About half the practice of a decent lawyer
    consists in telling would-be clients that they are damned fools and
    should stop.'' I would hope that those who attempt to induce others to
    illegally manipulate UI tax laws would heed Elihu Root's advice.
                                     ______

                                                              EXHIBIT 1
                       Unemployment Insurance Trust Fund:
            Recent Changes in North Carolina Employment Security Law
        Financial impacts of changes in ESC law were calculated for 1995
    forward. However, some changes made in 1993 and 1994 are provided
    because of their use of the `50 percent rule' or very similar rules.
    Changes effective January 1, 1993
        1.  The standard contribution rate for new accounts reduced from
    2.7 percent to 2.25 percent.
        2.  The contribution rate for positive-rated accounts was reduced
    by 30 percent, beginning April 1, 1993.
    Changes effective January 1, 1994
        1.  The standard contribution rate for new accounts reduced from
    2.25 percent to 1.8 percent.
        2.  The rate for positive-rated accounts was reduced by 50 percent
    in any year in which the trust fund balance on the previous computation
    date was $800 million or more.
    Changes effective January 1, 1995
        1.  The rate for positive-rated accounts was reduced by 50 percent
    in any year in which the trust fund balance on the previous computation
    date was $800 million or more and fund ratio was less than 5.0 percent.
    The rate for positive-rated accounts was reduced by 60 percent in any
    year in which the trust fund balance on the previous computation date
    was $800 million or more and fund ratio was 5.0 percent or more.
        2.  Accounts with a reserve ratio of 5.0 percent or more receive a
    zero rate. (Prior to this change, the lowest rate was 0.01 percent, and
    it applied to accounts with a credit ratio of 6.2 percent or more.)
        3.  The method of calculating taxable wages was changed to reduce
    taxable wages as a share of total wages. The taxable wage base is the
    greater of the federally required taxable wage base ($7,000) or the
    average annual insured wage multiplied by 50 percent, and rounded to
    the nearest multiple of $100. The above multiplier was reduced from 60
    percent to 50 percent.
    Changes effective January 1, 1996
        1.  All positive-rated accounts received a one-time zero rate for
    calendar year 1996.
        2.  The standard contribution rate for new accounts reduced from
    1.8 percent to 1.2 percent.
    Changes effective January 1, 2000
        1.  All UI contribution rates were reduced by 20 percent for
    calendar years 2000 and 2001.
        2.  All UI accounts paid a training contribution of 20 percent of
    the (reduced) UI rate for calendar years 2000 and 2001. (The maximum
    combined UI plus training rate was set at 5.7 percent. Thus if 20% of
    the UI rate would result in a combined rate above 5.7 percent, then
    that account paid a training rate that, when combined with the UI rate,
    would not exceed 5.7 percent.)
        3.  Accounts with a reserve ratio of 4.0 percent or more received a
    zero rate. (Prior to this change, accounts with a reserve ratio of 5.0
    percent or more received a zero rate). This was a permanent change; it
    has no sunset provision.
    Changes effective January 1, 2002
        1.  All UI contribution rates are reduced by 20 percent and all UI
    accounts pay a 20 percent training tax (based on the reduced UI rate)
    if the computation balance in the prior year is more than $900 million
    and the total unemployment rate is not above 4.3 percent at any time
    over the 12 months prior to the computation date. If the latter
    conditions are not met, then the training tax does not apply and all
    accounts pay their regular UI contribution rates. This is in effect
    through December 31, 2005. (The maximum combined UI plus training rate
    was set at 5.7 percent. Thus if 20% of the UI rate would result in a
    combined rate above 5.7 percent, then that account paid a training rate
    that, when combined with the UI rate, would not exceed 5.7 percent.)
                                     ______

                                                              EXHIBIT 2
                Employment Security Commission of North Carolina
                                  UI Tax Alert
                    For Immediate Release: February 24, 2003
                State Unemployment Tax Avoidance (SUTA Dumping)
        The Employment Security Commission (ESC) has become increasingly
    aware of the practice of State Unemployment Tax Avoidance (also called
    ``SUTA dumping'') in North Carolina. The agency has also learned that
    certain tax advisory companies are promoting this activity as a way of
    gaining business by promising potential clients reduced expenses and
    increased profits.
        The ESC will actively pursue and prosecute employers engaged in
    this activity and has the authority to subpoena records and individuals
    in its investigations. The maximum punishment is a fine imposed in the
    court's discretion and 45 days confinement.
        SUTA dumping is a practice of employing units to create new
    business entities, transfer employees--and, in some cases, a part of
    the organization, trade or business--to deliberately avoid an
    unemployment insurance (UI) tax rate and deficit in its experience
    rating account. The burden of the deficit is then shifted to all other
    employers.
        Employers engaged in this activity knowingly misrepresent the
    purpose of the new business entity on quarterly UI tax returns and
    reports. It is illegal under ESC statutes to knowingly make false
    statements and omit material facts on UI tax documents in order to
    reduce unemployment taxes. This practice is in violation of N.C. G.S.
    96-18(b), with a two-year statute of limitations:

             96-18. Penalties.
            (b) Any employing unit or any officer or agent of an employing
            unit or any other person who makes a false statement or
            representation, knowing it to be false, or who knowingly fails
            to disclose a material fact to prevent or reduce the payment of
            benefits to any individual entitled thereto, or to avoid
            becoming or remaining subject hereto or to avoid or reduce any
            contributions or other payment required from an employing unit
            under this Chapter, or who willfully fails or refuses to
            furnish any reports required hereunder, or to produce or permit
            the inspection or copying of records as required hereunder,
            shall be guilty of a Class 1 misdemeanor; and each such false
            statement or representation or failure to disclose a material
            fact, and each day of such failure or refusal shall constitute
            a separate offense.

        The ESC is developing a real-time tax analysis program to review UI
    tax account activity in order to detect signs and patterns of fraud.
    The agency's tax fraud detection efforts will target both active and
    inactive UI accounts.
        Employers can help protect the integrity of the UI Trust Fund and
    keep UI tax rates at minimum levels by being informed about this
    activity. Information may be reported to Anne Coomer, ESC Tax Status
    Manager, at 919-733-7156, or Ted Brinn, ESC Field Tax Operations
    Manager, at 919-733-7396. Any information provided and the source of
    the information will be kept confidential.
                                     ______

                                                              EXHIBIT 3

                                    ------

                                                              EXHIBIT 4
                       GENERAL ASSEMBLY OF NORTH CAROLINA
                                  SESSION 2003
                              SESSION LAW 2003-67
                                SENATE BILL 326
    AN ACT TO CLARIFY THE LAW ON CHANGING THE FORMS OF BUSINESSES FOR
                UNEMPLOYMENT INSURANCE TAX PURPOSES AND TO INCREASE
                PENALTIES, SO AS TO DETER THE PRACTICE OF STATE
                UNEMPLOYMENT TAX AVOIDANCE (SUTA DUMPING).

        The General Assembly of North Carolina enacts:

        SECTION 1. G.S. 96-9(c)(4) is amended by adding a new sub-
    subdivision to read:

              ``a1. A new employing unit shall not be assigned a discrete
            employer number when there is an acquisition or change in the
            form or organization of an existing business enterprise, or
            severable portion thereof, and there is a continuity of control
            of the business enterprise. That new employing unit shall
            continue to be the same employer for the purposes of this
            Chapter as before the acquisition or change in form. As used in
            this sub-subdivision:

               1. `Control of the business enterprise' may occur by means
            of ownership of the organization conducting the business
            enterprise, ownership of assets necessary to conduct the
            business enterprise, security arrangements or lease
            arrangements covering assets necessary to conduct the business
            enterprise, or a contract when the ownership, stated
            arrangements, or contract provide for or allow direction of the
            internal affairs or conduct of the business enterprise.
               2.  A `continuity of control' will exist if one or more
            persons, entities, or other organizations controlling the
            business enterprise remain in control of the business
            enterprise after an acquisition or change in form. Evidence of
            continuity of control shall include, but not be limited to,
            changes of an individual proprietorship to a corporation,
            partnership, limited liability company, association, or estate;
            a partnership to an individual proprietorship, corporation,
            limited liability company, association, estate, or the
            addition, deletion, or change of partners; a limited liability
            company to an individual proprietorship, partnership,
            corporation, association, estate, or to another limited
            liability company; a corporation to an individual
            proprietorship partnership, limited liability company,
            association, estate, or to another corporation or from any form
            to another form. This sub-subdivision shall not modify the
            provisions of G.S. 96-10(d)--Collections of Contributions Upon
            Transfer or Cessation of Business.

        SECTION 2. G.S. 96-18 is amended by adding a new subsection to
    read:

              ``(b1) Except as provided in this subsection, the penalties
            and other provisions in subdivisions (6), (7), (9a), and (11)
            of G.S. 105-236 apply to unemployment insurance contributions
            under this Chapter to the same extent that they apply to taxes
            as defined in G.S. 105-228.90(b)(7). The Commission has the
            same powers under those subdivisions with respect to
            unemployment insurance contributions as does the Secretary of
            Revenue with respect to taxes as defined in G.S. 105-
            228.90(b)(7).
              G.S. 105-236(9a) applies to a `contribution tax return
            preparer' to the same extent as it applies to an income tax
            preparer. As used in this subsection, a `contribution tax
            return preparer' is a person who prepares for compensation, or
            who employs one or more persons to prepare for compensation,
            any return of tax imposed by this Chapter or any claim for
            refund of tax imposed by this Chapter. For purposes of this
            definition, the completion of a substantial portion of a return
            or claim for refund is treated as the preparation of the return
            or claim for refund. The term does not include a person merely
            because the person (i) furnishes typing, reproducing, or other
            mechanical assistance, (ii) prepares a return or claim for
            refund of the employer, or an officer or employee of the
            employer, by whom the person is regularly and continuously
            employed, (iii) prepares as a fiduciary a return or claim for
            refund for any person, or (iv) represents a taxpayer in a
            hearing regarding a proposed assessment.
              The penalty in G.S. 105-236(7) applies with respect to
            unemployment insurance contributions under this Chapter only
            when one of the following circumstances exist in connection
            with the violation:

               (1) Any employing units employing more than 10 employees.
               (2) A contribution of more than two thousand dollars
            ($2,000) has not been paid.
               (3) An experience rating account balance is more than five
            thousand dollars ($5,000) overdrawn.''

        SECTION 3. Section 2 of this act becomes effective December 1,
    2003. The remainder of this act is effective when this act becomes law.
    In the General Assembly read three times and ratified this the 15th day
    of May, 2003.

          s/ Marc Basnight
             President Pro Tempore of the Senate
          s/ Richard T. Morgan
             Speaker of the House of Representatives
          s/ Michael F. Easley
             Governor

        Chairman HERGER. Thank you, Mr. Clegg. Now we will hear
    from Carl Camden, President and Chief Operating Officer of
    Kelly Services, Inc., Troy, Michigan. Mr. Camden.

        STATEMENT OF CARL CAMDEN, PRESIDENT AND CHIEF OPERATING
             OFFICER, KELLY SERVICES, INC., TROY, MICHIGAN

        Mr. CAMDEN. Thank you, Chairman Herger, Chairman Houghton.
    I am Carl Camden, President and Chief Operating Officer of
    Kelly Services, Inc., and I really do appreciate the
    opportunity to come here and talk with you all. This is also a
    very critical issue from Kelly Services, Inc.'s perspective.
    For a quick profile on Kelly Services, Inc., we were founded in
    1946. We are the second largest staffing company in the United
    States. We operate in all 50 States. We have 2,400 offices,
    but, most germane to today's presentation, we employ, in the
    course of a year in the United States, nearly 700,000 people.
        The practice of SUTA dumping, while it may have become more
    severe now, has been increasing slowly from the middle 1990s
    until now. In 1994, Kelly Services, Inc. received its first
    solicitation. The accounting firm who sent it to us asked us to
    keep it quiet because not very many people knew about it. Every
    year, as it has gone on, we receive more and more
    solicitations. Today, I will tell you that there is no large
    accounting firm who has not solicited Kelly Services, Inc. to
    engage in SUTA dumping, and you can add several dozen law firms
    and tax consultants. Perhaps what bothered me the most is last
    year, when one of my officers rejected the offer of SUTA
    dumping, and he received a very angry letter from the
    accounting firm which said, does the president of your company
    know you are doing this? You are betraying your fiduciary
    responsibility to your shareholders by costing your company
    several million dollars in profits that they could obtain if
    they would engage in this practice.
        It is rare, perhaps, to hear a businessperson speak in
    favor of a tax, but we at Kelly Services, Inc. believe that the
    SUTA tax system is intrinsically fair. If you control your tax,
    you control your unemployment experience, you keep your workers
    employed, you have a lower experience rate, then you pay less
    taxes. If you are unable to keep your workers employed, and you
    have a high experience rate, then you pay more taxes. Taxes go
    up. The taxes go down the better you do; they go up the worse
    you do. We understand that in an economic cycle, you will
    perform worse as the unemployment rate goes up, and you will
    pay more. Over the last two years--2003, and what we project
    into 2004--Kelly Services, Inc.'s contributions that we were
    required to pay into the State UI are going up by over $10
    million a year. We are not complaining about that. We also know
    they will go down in the future as our experience goes down and
    the unemployment problem becomes less.
        What irks me tremendously, though, is that in addition to
    the $10 million that is going up based on our own experience,
    we are also paying $1 to $2 million subsidizing people who are,
    in fact, engaged in SUTA dumping. That bothers me, and what
    really is a problem is that I face a competitive disadvantage
    as I compete against companies who engage in SUTA dumping and
    we don't. Their cost of service is less than ours--and it is
    significantly less. So, those of us who are trying to do what,
    in fact, is both legal and ethical, find ourselves at a
    competitive disadvantage as we compete against firms who engage
    in what in many States is, in fact, a legal but, we believe,
    unethical practice of SUTA dumping.
        Much of what you have heard today, I could duplicate--but I
    won't. I would like to address one particular issue, and that
    is the issue of urgency. I believe, in fact, that SUTA dumping
    is going to increase. It is in the process of increasing. If I
    judge it by nothing more than the rate of solicitations that we
    receive, and the number of references those companies are able
    to provide, I can tell you that the participation rate is high.
        As I dissect the rates that our competitors charge, it is
    easy to detect evidence of SUTA dumping. As the unemployment
    rate continues to increase, or even stay where it is, you can
    expect the contributions companies are to pay, and the
    unemployment tax to lag that by 1 or 2 years. In other words,
    the potential payback from SUTA dumping is going to increase
    over the next 1 to 2 years. While you have heard a number of
    $114 million, let me tell you that if Kelly Services, Inc. was
    willing to aggressively pursue SUTA dumping, taking everything
    all the way to the edge, we alone could save between $20 and
    $30 million dollars. So, $110 million strikes me as a low
    estimate. More importantly, I am asking you to consider the
    potential damage that is going to be done over the next 1 to 2
    years if we do not step forward and halt the abuse, and make it
    clear that while it may currently be a legal practice, it is
    not a practice that should be allowed to continue. We very much
    believe that there is a set of small actions that could be
    taken that would have a significant impact on reducing this.
        We do believe that States should be required to revise
    their laws to require mandatory transfer of unemployment
    experience for mergers, acquisitions, transfers of trades, or
    business. Yes, there is always a legitimate--there are many
    legitimate reasons to set up businesses, to break apart
    divisions, but there is never a legitimate reason not to
    transfer the work experience that those employees had before
    they moved into the new unit. We encourage the Department of
    Labor to develop tools and training, because I think the States
    are willing, but the knowledge is weak as to how you go about
    detecting and enforcing it. We would like to see appropriate
    enforcement by the States of the laws that are already on the
    books.
        Let me conclude with a paragraph from one of the last
    letters of solicitation that we received where somebody was
    asking us to engage in SUTA dumping in the State of
    California--and of course they were willing to do so for a fee.
    It is important to note that, in accordance with section 135.1
    of the California Unemployment Insurance Code, the State could
    assert a continuity of control and ownership and thereby treat
    Kelly Services, Inc. and the new company as a single employer.
    However, it has been our experience that the State will not
    impose this section of the law. We have to enforce the laws we
    have. We need to require the mandatory transfer of experience,
    and we need to provide the States with the tools they need to
    take care of the problem. Thank you, Mr. Chairman.
        [The prepared statement of Mr. Camden follows:]
    Statement of Carl Camden, President and Chief Operating Officer, Kelly
                         Services, Inc., Troy, Michigan
        Good afternoon Chairman Herger, and Chairman Houghton, and members
    of the Subcommittees on Oversight and Human Resources. I appreciate the
    opportunity to speak with you today regarding our shared goal of a
    strong, viable and sustainable unemployment insurance program.
        I am Carl Camden, President and Chief Operating Officer of Kelly
    Services. For those who may not be familiar with Kelly, the company was
    founded in 1946 and today is the second largest staffing services
    company in the United States. Our employees work in 50 states and in 26
    nations. We own and operate our own branch network of 2,400 offices.
    Last year Kelly employed nearly 700,000 people.
        Kelly Services recognizes the importance of an effective
    unemployment insurance system for workers, employers, and the economy
    as a whole. We applaud today's hearings to examine ways to improve and
    protect the system and to serve the needs of the unemployed.
        Employers pay unemployment taxes at rates commensurate with claims
    activities by their employees. Employers with high unemployment
    activity are assigned higher unemployment tax rates, and employers with
    lower activity pay less. This fundamental principle--called experience
    rating--has worked well for years, but is now being undermined. A
    growing number of employers are engaged in tax avoidance schemes
    designed to disguise their claims experience. This practice, known as
    SUTA dumping, is a threat to the integrity and health of our
    unemployment system. The practice harms both workers and employers who
    play by the rules.
        Workers are harmed because this questionable practice eliminates
    the incentive for employers to keep employees working--they can escape
    the financial harm that otherwise comes with laying off workers. State
    trust funds are depleted, taking away the flexibility to even consider
    benefit or eligibility changes.
        Employers are harmed because they must pay more to make up for the
    taxes that other companies avoided through SUTA dumping.
        It is important that Congress act promptly to solve this problem.
    The long-term labor market trends that make this practice attractive to
    some employers will continue--and accelerate. The adverse impact on the
    financial health of the unemployment insurance system will also
    continue to grow significantly.
        As the proportion of service workers in the economy continues to
    increase--they comprised 16% of the workforce in 1960, and grew to 36%
    by 2000--so will the temptation to engage in SUTA dumping. This is
    because payroll taxes are a large and important part of a service
    company's total tax burden.
        Because of the economic slow down, unemployment rates have risen
    significantly. Therefore, it is important to realize that the most
    opportune time for SUTA dumping is following a slowdown, when
    unemployment tax rates are high, as they are now and will be for
    several years.
        As you know, state unemployment trust funds are under significant
    stress with the states of Illinois, Minnesota, Missouri, New York,
    North Carolina and Texas already borrowing from Federal accounts.
    California and Massachusetts will likely need to borrow before the end
    of the year.
        In the staffing industry, people are our business. Therefore,
    payroll is our largest single cost. In 2002, Kelly's total U.S. payroll
    was $2.1 billion. Our taxable payroll was $1.4 billion, or 66% of our
    total payroll. If Kelly can reduce our unemployment tax rate by just
    one tenth of a percent, we can save $1.4 million. Small rate changes
    have a big impact.
        Because it is such a significant cost, we manage our unemployment
    compensation activities closely. We work hard to return employees to
    work as quickly as possible when economic conditions force layoffs. We
    provide training to upgrade employees' skills and increase the number
    of jobs they qualify for. We contest claims that we think are without
    merit.
        The staffing industry has been particularly hard hit by the current
    state of the economy. In 2003, Kelly's unemployment taxes increased by
    $12 million. But this is how the system is supposed to work. Tax rates
    increase following periods of high claims activity. On top of the 2003
    increase, we estimate an additional increase for 2004 of $14 million.
    Through a systematic SUTA dumping program, we could have avoided the
    entire $26 million dollar increase. These are the kinds of increases
    that some companies have avoided through SUTA dumping.
        These numbers are certainly large enough to get attention.
    Therefore, it is easy to understand why SUTA dumping is very tempting
    for labor-intensive organizations. I assure you that the numbers are
    significant enough to impact the competitive balance in the market
    place.
        Kelly and the other companies who have said no to SUTA dumping are
    faced with two basic choices.

          We can ignore the issue, and allow a questionable
    practice to continue to threaten our competitiveness.
          Or, we can seek appropriate changes to eliminate SUTA
    dumping, and to protect and preserve the unemployment insurance system.

        At Kelly Services, we choose the latter. We therefore urge Congress
    to act quickly to protect the integrity of the experience rating
    principle. We are suggesting that Congress:

          Require that state laws be revised to require the
    mandatory transfer of experience for mergers, acquisitions, and
    transfers of trade or business, regardless of the ostensible reason for
    the transaction.
          Direct the Department of Labor to develop tools and
    provide funding to train state agencies to detect the practice.
          Require appropriate enforcement by the states, of laws
    already on the books.

        Chairman Herger, Chairman Houghton, we appreciate the work of your
    committees, the work of the Department of Labor, and of the state of
    North Carolina--and other states--on this important issue. Thank you
    for the opportunity to appear today. We look forward to working with
    you in any way we can.

        Chairman HERGER. Thank you, Mr. Camden. Chairman Houghton
    to inquire.
        Chairman HOUGHTON. I think we all agree that this is not a
    great practice, and we ought to try to curtail it. I guess the
    issue that worries me is how far the Federal Government should
    go on something like this. If I understand it correctly, if you
    are in compliance in terms of the UI, it comes to about 0.8
    percent of payroll--but if you are not in compliance, the tax
    jumps up to 6.2 percent of payroll.
        Also, it is the testimony of Mr. Clegg that you can get up
    to 6 months or 8 months for aggravated circumstances--all sorts
    of penalties that are already existing there. So, what can the
    Federal Government do to superimpose its will, its might, its
    discipline, on this whole system, which seems to me is just
    being violated but the structure that is in place? Maybe I am
    wrong. Maybe you can explain.
        Mr. CAMDEN. I will take a first pass at it, although I find
    myself an unlikely character to be arguing for a larger Federal
    role in any lives. It is not my particular political bent.
    Ultimately, though, a failure at the State level requires the
    Federal Government to backstop the failure. Yes, three States
    have currently borrowed. We anticipate at Kelly Services, Inc.
    that the number is actually going to be closer to eight States
    by the end of the year, and of those eight small States,
    perhaps we wouldn't mind.
        Let me go through the list of States that the Federal
    Government can expect borrowing from before this year is over:
    Illinois, Minnesota, Missouri, New York, North Carolina, and
    perhaps Texas, California, and Massachusetts. These are not
    small States with small payrolls. While, if we leave it to the
    State issue, we ultimately leave it to the Federal Government
    to hold the bag for the borrowings that take place.
        Second, you already have current law that requires the
    Federal Government to set the standards by which the States
    act. This issue of a mandatory transfer of experience has not
    been established as a principle by which the States need to
    behave--by which the States need to enact legislation. That
    principle needs to take place, and it needs to be enforced at
    the local level.
        Finally, the provision of tools--because ultimately,
    enforcement does take place at the State level. The provision
    of tools, the provision of training, enables the States to
    carry out the actions that I think we all expect them to do. Do
    you have a different perspective?
        Mr. CLEGG. Yes, thank you. I am certainly not one who is
    going to argue for overreaching Federal interference in State
    issues either. However, we do have, and currently function as a
    State employment security agency under Federal conformity and
    compliance issues, which do establish a basic umbrella of
    consistency across the Nation.
        My overriding concern with the issue of SUTA dumping, if it
    is completely left at the States--if I thought every State
    would go adopt the law that North Carolina has just passed, I
    would sleep well. I don't think that would happen, and
    therefore I don't think we need to get into a situation where
    people will SUTA shop and deal with multi-state entities in
    States with less severe penalties for SUTA dumping. So, I think
    that we need to look at it in the larger umbrella context as a
    conformity and compliance issue, but leave the specifics to the
    State, as we have in so many other benefit areas.
        Chairman HOUGHTON. Would you like to answer?
        Mr. DESAULNIERS. I would like to point out the results of
    our survey, indicating that although there are States such as
    North Carolina which are moving aggressively in this area,
    three-fifths of the State administrators indicated to us that,
    either they had no laws dealing with this issue, or that their
    laws were inadequate. So, yes, there are some States that are
    handling it well, but three-fifths of the State administrators
    report that their States are not addressing this issue
    adequately.
        Mr. CAMDEN. For a tax evasion scheme that began to appear
    in the mid-1990s and has picked up steam today, to have only
    one State that we are able to bring forward today as a witness,
    argues for the need for a more centralized, collective, and
    fast response.
        Chairman HOUGHTON. Yes. If I understand it, what you are
    saying is the Federal Government should pass the law to make
    sure that the States have the proper features, and also enforce
    those laws--not to superimpose a Federal law on it so as to
    encourage the States. Thank you very much, Mr. Chairman.
        Chairman HERGER. Thank you. The Ranking Member, Mr. Cardin,
    from Maryland, to inquire.
        Mr. CARDIN. Thank you, Mr. Chairman. Mr. Cramer, I guess
    after listening to all four of your testimonies here, I am
    convinced by the statement of Mr. Clegg that if SUTA dumping
    can exist in North Carolina, it surely must exist in every
    State. I am concerned that--as Mr. Camden has indicated--there
    could be a $20 million hit on one company alone, Kelly
    Services, Inc., that when you get two-fifths of our States
    saying they have adequate laws or enforcement, I question
    whether that, in fact, is true.
        Mr. DESAULNIERS. The two-fifths comprises both those who
    believe that efforts are adequate, as well as those who are not
    aware of, or may not be aware of, the extent of the SUTA
    dumping practice in their States. So, it is a----
        Mr. CARDIN. In fact, they are the ones worrying me the
    most, because they are the administrators who believe they
    don't have a problem when in fact they do have a problem. They
    are not looking at what is probably happening within their
    States. So, I really do think that we don't know the extent of
    the problem, but that it is clearly going to continue to grow
    unless we have a national policy.
        Now, I don't disagree with Chairman Houghton. This is a
    State-administered program, so we have to rely upon the States
    to enforce their laws. However, there has got to be a clear
    message nationally that we won't tolerate this type of action,
    because it won't take long for Mr. Camden to get in a position
    where he will have no choice but to explore this practice if
    his competitors are doing it. I would be curious as to what
    impact you think this may have on competition. If you continue
    to pay the extra, perhaps, $20 million, and a competitor
    doesn't pay that $20 million, it seems to me you can't do that
    for too long in too many different categories.
        Mr. CAMDEN. I ask myself that question every now and then
    also. There are traditional responses. We work very hard at
    training, upgrading our employees, and making them more
    employable. We are very fast at trying to get them employed at
    a temporary staffing firm. We are aggressive at understanding
    when assignments are going to end, and reassigning. Through
    what I view as just good, solid business practices, we have
    managed to keep our unemployment experience lower than most of
    our competitors, and so SUTA dumping hasn't put us at as much
    of a competitive disadvantage as we have experienced in the
    last year or two.
        I have a chief executive officer who talks to our
    management team about what he calls the Wall Street Journal
    test. Which is, he doesn't want to hear about if something is
    legal or not; he wants to hear that, if it is on the front page
    of the Wall Street Journal, how are we going to feel about
    having to explain it to a reporter----
        Mr. CARDIN. That sounds like a Member of Congress.
        Mr. CAMDEN. I have to tell you, it would be hard for me to
    explain to a reporter why it is that we would engage in that
    practice. We will continue to not engage in SUTA dumping, but
    we will be aggressive at talking to you all here, talking to
    others, and doing what we can to bring about--again, rare for
    me to say--the active enforcement of what we think is,
    intrinsically, a fair tax.
        Mr. CARDIN. It is nice to see there are such things as
    corporate ethics these days. That is good to hear from you. Mr.
    Clegg, I am curious as to what response you are receiving from
    the business community in North Carolina. Are you getting
    support? Are there companies that are a little bit nervous
    about what you are doing?
        Mr. CLEGG. North Carolina has about 178,000 employers, and
    many of them are represented by two major business lobbying
    groups in North Carolina--both of whom joined in support of
    this piece of legislation. I think what Mr. Camden says is very
    clear. The vast majority of employers do not want their
    experience ratings skewed by the actions of some of the folks.
        The issue of the trust fund in North Carolina had not been
    an issue for many, many years because we had about $1.6 billion
    and very low unemployment, and all of a sudden we had 6.4-
    percent unemployment and the trust fund was nearly empty.
    Everyone's UI tax rate is now an issue of discussion within the
    business community, and the Certified Public Accountants
    Association, plus the major business lobby promotion
    associations in North Carolina, joined with us in very positive
    testimony before both the North Carolina House, and the North
    Carolina Senate as this bill made its way through the General
    Assembly.
        Mr. CARDIN. Again, let me thank all of you for your
    testimony. That is certainly very helpful.
        Chairman HERGER. Thank you very much. Mr. Clegg, I want to
    join in commending your State, North Carolina, for very
    aggressively going after this which is obvious, and appears to
    be becoming a growing problem. I also commend your business
    community for supporting you. Mr. Camden, I have to
    particularly commend you and your company, Kelly Services,
    Inc., for taking the strong ethical stand that you have.
        The purpose of this hearing today is to, first of all,
    identify if there is a problem and what that problem is, one;
    and then, two, to move forward and identify what it is we need
    to do as a Congress--what we can do, what would be the most
    effective way to alleviate this problem. Mr. Camden, if you
    could tell me, in your opinion, what are the prime issues that
    need to be addressed to prevent and stop SUTA dumping?
        Mr. CAMDEN. I think the critical issue is the transfer of
    experience, and we need to not let that issue get clouded up
    with the legitimate needs of countries to divide businesses. We
    have a health care business. We provide scientists, engineers--
    and all of them we have in separate businesses, because they
    have very different business practices.
        The issue is not that you can form companies, or even
    necessarily combine companies. It is to require that the
    experience goes with you, because there is no legitimate reason
    for that experience not to come with you as you separate and
    combine entities. The purchasing of companies just to acquire
    their unemployment rate is not a--I don't believe it to be a
    rare occurrence. That is just, in my opinion, out-and-out
    fraud. Again, we may not have made it illegal yet, but it is
    clearly not the intent of the legislation that was passed for
    that to occur.
        We need to clearly establish that there are principles that
    we are following, and one of those principles is the mandatory
    transfer of experience. I think that that is a code that can be
    passed by this Committee. I think that that is an expectation
    that all the States have. I think we could even go beyond that
    and do something that would be very common in business--perhaps
    not so common here.
        Why aren't there performance metrics that we are requiring?
    Why don't we require the States to have--to achieve an
    increasingly difficult set, to raise the bar--as we talked
    about in the corporate setting where we expect to see more
    actions, more investigations, and a more complete explication
    of the mandatory transfer of experience regulation. I
    understand that enforcement is local. The question is, are we
    going to make it easier for the States to make that enforcement
    effective, by giving them the tools they need, by providing the
    training--but, most importantly, by making very clear and very
    explicit what is illegal?
        I really dislike receiving letters saying that SUTA dumping
    is not illegal. It is against the intent of the law. We simply
    haven't made explicit how the intent of the law is to play out
    in the transfer of work experience as companies go about
    combining and dividing. That single change alone, and requiring
    States to amend their laws to come to conform with that
    principle, would have a massively positive impact. Public
    statements by you all, who are much better at speaking at this,
    and command a much better podium than we would, perhaps,
    individually, would let the business community know there is no
    room--and would let those, the promoters, know there is no
    tolerance for going around the spirit of the legislation with
    something that may be legal, but violates the spirit of the
    law.
        Chairman HERGER. Thank you, Mr. Camden. Again, what can be
    pointed out is, not only are they saving these dollars and
    becoming more competitive in an ethically, I believe, dishonest
    way. Those who are being ethical, who are abiding by the law,
    are paying the difference in higher unemployment rates than
    they would be paying had this not been taking place. So, one is
    gaining at the expense of all the others like yourself who are
    obeying the law. The gentleman from Michigan, Mr. Levin, to
    inquire.
        Mr. LEVIN. Thank you. Well, I think to my colleagues, the
    witnesses have laid out the problem very clearly--and, I think,
    the answer. I had the privilege of representing for 10 years--
    until 6 months ago--the city in which Kelly Services, Inc. is
    headquartered, and had a chance to come and know the company
    well. I think we have to do more than admire the company, which
    I do very much. The gentleman from Kelly Services, Inc. told me
    about what the response was from a person who headed up the
    company for so many years, when he asked, knowing the answer,
    whether they should engage in this. The answer was, no way. The
    State of North Carolina has made it clear how this can be done,
    and I think that the GAO has described how, if we don't act,
    there will be people promoting activity that should not occur.
        So, I wanted to just say a few words about the issue that
    Mr. Houghton has raised--and that is the Federal interest. It
    seems to me that there is clearly a Federal-State partnership
    when it comes to employment compensation. This is a combined
    system, and the Federal Government has laid out certain
    parameters within which States must act. The question is
    whether this will be added to the parameters. It isn't as if
    the States simply send the money here, we ship it back, and
    there is no role for us. I think this is an especially urgent
    issue when we have this high level of unemployment, when States
    need more resources, not less, to address the needs of the
    unemployed--including addressing the issues of eligibility.
    Whatever the figure is, the percentage of people who receive
    unemployment compensation is less than 50 percent of the people
    who become unemployed.
        It is also, I think, a Federal issue. We don't want States
    competing for which ones can do worse for their unemployed
    personnel or Members. We don't want competition based on that,
    and we don't think it is right that employers compete against
    other employers as to who can game the system. That is exactly
    what is happening here. People are gaming the system. There is
    such a clear Federal role--and there is an urgency here. If we
    don't act this year with unemployment the way it is, with the
    recession continuing in one form or another, or with economic
    difficulties, whatever you want to call it, there is going to
    be more and more of this, in all likelihood. North Carolina has
    shown us a model as to how it can be done. It seems to me that
    we have that experience--we have got the experience of States
    that know how to do it.
        The Department of Labor and the administration ought to
    send us some legislation, and do it quickly. Then we need to
    get down and work on it, pass it, and do so in the next few
    months. If we don't do that, then it won't have any impact for
    the next year when the experience ratings come out, and we are
    going to be talking about another year and a half of companies
    gaming the system to the harm of their competitors--to the harm
    of employees who are laid off. There aren't the funds there for
    States to work with, and it is to the harm of the Federal
    Government, which is now loaning out monies to the States. It
    affects all of these resources. So, I think Mr. Houghton's
    question is a very appropriate one, and I think that these four
    witnesses have given us such a clear answer, that now it is up
    to us and the administration. Thank you so much for the four of
    you appearing. You have thrown down the gauntlet, and we need
    to pick it up.
        Chairman HERGER. Thank you, Mr. Levin. The gentleman from
    North Dakota, Mr. Pomeroy, to inquire.
        Mr. POMEROY. Thank you, Mr. Chairman. I will be brief. I am
    very interested in the information you have brought us, and
    ascribe myself fully to the comments of the gentleman from
    Michigan. If consultants are marketing essentially illegal
    practices, we need to put a stop to it. In addition, we need
    to, I think, fully air who is doing this and what is out there
    by way of competitive pressures. I was very surprised to learn
    the major accounting firms are in a frantic competition with
    one another relative to tax shelters. I had a friend who was a
    partner in one. He hated it. He wanted to be a consultant and
    an accountant, not a salesman on shady accounting schemes. That
    was what he was reduced to, and competition drove right across
    the biggest accounting firms in this country. Who are the
    consulting firms that are selling these products? One of the
    GAO representatives here, if you could go ahead and name them,
    I think that is important information.
        Mr. DESAULNIERS. Congressman, GAO has a policy that we do
    not, in a public forum, disclose names. I would be happy to
    disclose those names to you privately, or with your staff after
    the hearing, but it is our policy not to publicly name names.
        Mr. POMEROY. Well, let me just see, then, if there is any
    other way I can get it out of you. Would I recognize the name?
        Mr. DESAULNIERS. I do not think so.
        Mr. POMEROY. That tells me it is not one of the major
    accounting firms that----
        Mr. DESAULNIERS. No, it is not.
        Mr. POMEROY. I am relieved to hear that. We don't have any
    information that they are doing this, do we?
        Mr. DESAULNIERS. Well, I think that Mr. Camden provided
    that information.
        Mr. CAMDEN. The answer is that they all have over the past
    few years. I disagree somewhat with the characterization that
    it is illegal, because if it was clearly illegal, it would have
    been easier to stop it. We have been careful to use the word
    unethical, and not the phrase, ``true to the spirit of the
    law.'' They have proposed unethical schemes, maybe pushing
    right up to the edge of the gray zone. I know these firms. I
    know many of the partners, and I don't believe that they
    crossed into an area that they would view as blatantly illegal.
    I happen to think that is the wrong standard, but I would
    object to the characterization as selling an illegal practice.
        Mr. POMEROY. Right. I am reading here from an article that
    appeared on Charlotte.Com--in the Charlotte Observer. ``It is
    clear at least two major accounting firms, Deloitte & Touche
    and Peat Marwick International/Klynveld Main Goerdeler (KPMG),
    were pushing the maneuver in North Carolina as recently as last
    fall, according to publicly available documents and Observer
    interviews with officials from three companies who said they
    were pitched the technique.''
        So, Mr. Camden, maybe you can tell me how this works. So,
    you have got--assuming the information in this is correct--
    people from Deloitte & Touche or KPMG coming up and saying, we
    think you ought to hire us as a consultant, let us show you
    what we can save you in your unemployment compensation
    benefits--we think that you can basically shift some of the
    risk here. Basically, they then would go on to elaborate a SUTA
    dumping procedure, and then hope that the employer would hire
    them so they could do the template on SUTA dumping for purposes
    of artificially reducing their risk for purposes of UI premium?
        [The information follows:]

    Accounting firms' role in tax ruse scrutinized
    Results in lower N.C. jobless taxes
    TONY MECIA
    Staff Writer
        As Congress holds hearings today on an accounting maneuver some
    companies use to skirt unemployment taxes, N.C. investigators are
    examining the role major accounting firms played in the controversial
    practice.
        The accounting move occurs when a company creates subsidiaries that
    pay less money than they ordinarily would into a state fund for jobless
    workers. Officials with the N.C. Employment Security Commission worry
    that the practice is sucking millions of dollars from the fund--and
    sticking companies that don't use the technique with higher tax bills.
        The General Assembly passed a law last month clearly criminalizing
    the practice. Today, North Carolina's enforcement efforts will be
    presented in a Subcommittee hearing of the House Ways and Means
    Committee in Washington, which is concerned about abuses under the
    practice.
        Since launching their investigation late last year, N.C. officials
    have focused on the companies employing the practice, which the state
    says are principally manufacturers and construction firms.
        But now, state officials say they have developed a better
    understanding of the companies pushing the technique, which officials
    call state unemployment tax dumping, or ``SUTA dumping.''
        ``It appears that major accounting firms believe they can make
    money by selling SUTA dumping plans to North Carolina businesses,''
    said Fred Gamin, a senior staff attorney with the ESC who is heading
    the investigation. ``It's illegal.''
        Gamin would not name the accounting firms under scrutiny, although
    he said the ESC is looking at companies that advocated the technique as
    well as those that performed outside audits of firms that used it. It's
    unclear what action the ESC may take.
        But it is clear that at least two major accounting firms--Deloitte
    & Touche and KPMG--were pushing the maneuver in North Carolina as
    recently as last fall, according to publicly available documents and
    Observer interviews with officials from three companies who said they
    were pitched the technique.
        They were pushing the technique in 2001 and 2002, just as a series
    of financial scandals subjected the accounting industry to renewed
    scrutiny. At the same time, the economy was sluggish, and employers
    were beginning to pay higher unemployment taxes to pay for increased
    numbers of jobless claims.
        Deloitte, which told The Observer in January it believes the
    technique to be legal and was advising companies on how to use it,
    declined to comment for this article.
        KPMG spokesman Tim Connolly said Wednesday, ``Our advice was
    consistent with the law, but we don't discuss the work we perform for
    clients.''
        In a report to be released at the congressional hearing today, the
    General Accounting Office said tax consultants are continuing to advise
    companies on the maneuver. A GAO investigator, posing as the owner of
    an East Coast construction company, asked four consulting firms about
    avoiding unemployment insurance taxes. Three of the firms offered to
    help; the fourth demurred, explaining that the practice is illegal in
    many states. The GAO didn't name the firms.
        According to representatives of the three companies interviewed by
    The Observer, the pitch generally went like this:
        The accounting firms would call the financial offices of targeted
    companies, briefly explain the technique and seek to set up a meeting.
    The cost of implementing the practice ranged from $50,000 to $150,000.
        But the savings, they said, could be far greater. Other companies
    are doing it, they said.
        One of the companies interviewed by The Observer, an N.C.
    manufacturer, said KPMG's Charlotte office promised significant savings
    by using the accounting method. In a letter to the company last fall,
    which The Observer was allowed to read, KPMG said it had saved an N.C.
    textile company $6 million in unemployment taxes over three years.
        The company's chief financial officer told The Observer this week
    that he found the offer tempting but declined because it didn't seem
    ethical, even if it was legal.
        ``Our feeling from the beginning has been, this is borderline
    fraud,'' said the CFO, who said he also received a similar pitch from
    Deloitte.
        Fearing business fallout from being quoted publicly, he asked not
    to be identified.
        Another company, R.L. Stowe Mills Inc. in Belmont, said it found no
    compelling business reason to use the technique when a major accounting
    firm pitched it last fall, even if it would have resulted in ``very
    significant'' savings.
        ``We did not give it a lot of consideration because it didn't feel
    right to us,'' said CFO Barry Pomeroy, who would not name the
    accounting firm. ``It seemed to us to be more of an evasion technique
    rather than an avoidance technique. We'll avoid taxes legally all day
    long, but when you get into evasion. . . .''
        A manager with the third company told The Observer its executives
    relied on assurances from Deloitte when they bought into the maneuver.
    In a meeting in the second half of 2001, the manager asked a Deloitte
    tax adviser if the move was legal.
        ``There was not always a direct answer back to me, other than the
    fact that there was a loophole there,'' said the person, who asked not
    to be identified for fear of retribution.
        The plan, the manager said, was to create new subsidiaries every
    year, regularly transferring workers into them. That would enable those
    units to pay low tax rates because they have no history of layoffs--or
    of tapping the state fund established to pay benefits to laid off
    workers.
        The Charlotte-area company used the practice, saving several
    hundred thousand dollars in 2002. But ``things got hot'' in January
    2003 when The Observer published an article saying state officials were
    examining the practice, the manager said. The workers were then
    transferred from the subsidiary back to the original company.
        At the time, state law did not specifically address the technique,
    and several tax advisers told The Observer they considered it to be
    legitimate tax planning. Later, state officials said they considered
    the practice illegal. They made sure it was in the N.C. law passed in
    May.
        The state is continuing to investigate about a dozen companies that
    have used the practice. ESC officials have declined to name them. They
    have collected $18,000 in back taxes from one Virginia-based
    manufacturer with N.C. operations, and say they nixed the company's
    attempt to skirt about $400,000 a year.
        Nationally, several states including North Carolina identified a
    total of $120 million in losses from SUTA dumping in the past 3 years,
    the GAO reports.
        As recently as this March, Deloitte was still encouraging use of
    the practice in other states.
        In a March 25 tax seminar archived on the firm's Web site, a
    principal with Deloitte's Boston office said state unemployment tax
    planning was ``still valid planning'' because other states ``have not
    made a movement to change this law yet.''
        But in light of heightened attention by N.C. newspapers and by the
    U.S. Department of Labor, he recommended transferring into the
    subsidiaries not just employees, but also assets. Give the subsidiaries
    more heft, he advised, by creating a ``business-purpose document'' and
    doing financial statements for them.
        ``The more substance that we have in these transactions,'' he said,
    ``the more we can hold our head high.''

        Mr. CAMDEN. Yes, sir.
        Mr. POMEROY. I think that stinks, and I think that an
    important part of the responsibility that Chairman Houghton and
    I have in the Subcommittee on Oversight, is to bring this
    information out in public forum. I would like to think that, if
    business ethics don't mean anything anymore to some of the
    firms that we have long held in the highest light--in terms of
    their adherence to business ethics and business standards--then
    hopefully the prospect of corporate embarrassment ought to mean
    something to them. It is an old adage among Members of
    Congress: don't do anything you wouldn't want to read about in
    the paper.
        Well, I would like to see these guys think at least twice
    about--don't do anything you don't want tossed around a
    Committee on Ways and Means hearing room in public forum. I
    really do think that that is beneath the proud reputation of
    Deloitte & Touche and KPMG, and beneath the fine people that
    work in those firms. I appreciate very much what you have
    brought to us in this regard, and look forward to bringing
    information out.
        Chairman HERGER. I thank the gentleman from North Dakota.
    Chairman Houghton, to inquire.
        Chairman HOUGHTON. I want to bring this thing back into an
    overall perspective. Since the beginning of time, people have
    tried to game the system, and they will continue to game the
    system. We have seen it, whether it is public accounting white-
    washing, or whether it is earnings stripping, or a special
    partnership and off balance sheet borrowing--or whatever it is.
    As far as SUTA dumping is concerned, clearly it is wrong--it is
    not in the spirit of what we are all about, what this country
    stands for, what the laws, and its intentions, are. The
    question is, what do you do about it--and the thing I think we
    have got to be careful of, is that we don't use a sledgehammer
    on something where it will have real shock waves in other
    areas. I was in business for many, many years, and good laws
    were put in under extraordinary circumstances. Yet they had a
    paralyzing effect on a variety of different actions which we
    wanted to take. So, as we make these decisions up here, we want
    to be conscious of that, and we want to make sure that we
    attack the problem and just don't ruin the system. I just
    wanted to say that, Mr. Chairman, and I thank you very much for
    being here.
        Chairman HERGER. Thank you, Chairman Houghton. Certainly I
    have to echo the comments of Chairman Houghton. We certainly
    don't want to do anything that is going to disrupt what our
    natural business practice is, but I believe what we have been
    hearing about in this hearing are not natural business
    practices. These are practices that, as I hear the testimony,
    are made to game the system--and this is at the expense of
    other employers and other businesses who are placed in a very
    unfair competitive position because of this. So, it is
    something that this Committee intends to work with you to help
    correct. With that, my last question would be to any of you who
    would like to comment. How difficult is it for States to
    identify companies that engage in this SUTA dumping practice?
    Any of you wish to answer?
        Mr. CLEGG. To begin with, we knew that it was out there,
    but we did not truly uncover it until we looked at our
    voluntary contributions. States have got to, number one,
    acknowledge the fact that SUTA dumping exists. It is an
    emerging issue. Some States are so deep in trying to dig out of
    their current unemployment issues, they are not having the
    resources to deal with the tax end of the house. Through that
    acknowledgment--through an acknowledgment that this is
    occurring in a multi-state situation--we are acknowledging that
    we don't want people to SUTA shop. Education has a lot to do
    with it, but our real time computerized program is allowing us
    to make that determination by looking at factors which we have
    seen across the board that SUTA dumpers have in common with one
    another.
        Every entity that pulls up in our system is certainly not a
    SUTA dumper, but it is clearly a way to look at very clear
    evidentiary factors that we have seen across time that might
    bear further investigation. The 10 individual corporations we
    will be going to see in the next 30 days were determined from
    that very program, and we certainly hope to be able to, in
    forums like this, discuss that program. We hope to be able to
    help other States determine that, as State employment security
    agencies, we are all in the same boat, and what hurts one hurts
    us all, particularly with the multi-state and transient nature
    of commerce in today's world. We are not living in a vacuum,
    and it is very important that we all understand the severity of
    this problem, and all do something about it.
        Chairman HERGER. Thank you very much. Again, I appreciate
    your testimony--for your coming here today. It has been a very
    interesting and informative hearing. It has also been a
    pleasure to work with our colleagues on the Subcommittee on
    Oversight. With that, this hearing stands adjourned.
        [Whereupon, at 3:30 p.m., the hearing was adjourned.]
        [Submission for the record follows:]
        Statement of the National Association of Professional Employer
                      Organizations, Alexandria, Virginia
        The National Association of Professional Employer Organizations
    (NAPEO) appreciates the opportunity to submit this statement for the
    record of the Subcommittees' June 19, 2003 hearing to examine fraud and
    abuse in the Unemployment Compensation program. We commend Chairman
    Herger and Chairman Houghton and the members of the Subcommittees for
    providing the oversight necessary to protect the integrity of this
    important State-Federal partnership and to protect workers and
    employers who play by the rules. Like other employers, professional
    employer organizations (``PEOs'') benefit from a strong and equitable
    Unemployment Compensation program, and NAPEO supports broad-based
    efforts to eliminate any practice that undermines the integrity of the
    system.
        As you are aware, the Unemployment Compensation program is
    supported by unemployment taxes paid by employers. Today, state
    programs rely on the basic concept of ``experience rating'' to
    establish a particular employer's rate of taxation. Under an experience
    rated system, an employer with a higher incidence of successful claims
    for unemployment benefits pays a higher rate of unemployment tax than
    an employer with fewer successful claims. Unfortunately, evidence
    suggests that some employers are engaging in aggressive business
    practices designed to artificially improve their experience rate,
    thereby avoiding their unemployment tax liability. This ``SUTA
    dumping'' can undermine the stability and integrity of the experience
    rated Unemployment Compensation program. NAPEO has supported, and will
    continue to support all efforts to curb SUTA dumping that (1) apply
    equally across the board to all employers engaged such practices, (2)
    are carefully crafted to recognize legitimate corporate restructurings,
    and (3) do not penalize employers who choose to utilize the services of
    a PEO.
        NAPEO has nearly 500 members found in all 50 states, and represents
    more than 70% of the industry. PEOs assist mainly small and mid-sized
    businesses, covering almost every American industry, in fulfilling
    their responsibilities as employers by assuming many human resource and
    employment functions of the PEO customers. The PEO generally assumes
    responsibility for paying wages and employment taxes for all the
    workers of its client companies. It maintains employee records, handles
    employee complaints, and provides employment information to workers.
    Significantly, the PEO provides workers a variety of benefits,
    including retirement (usually a 401(k) plan), health, dental, life
    insurance, and dependent care. For many of these workers, the provision
    of such benefits by the PEO represents their first opportunity to
    obtain these benefits.
        Of particular relevance to this hearing, PEOs enhance and create
    efficiencies in the unemployment compensation system by serving as the
    entity responsible for unemployment insurance of all worksite
    employees. Not only does the PEO maintain extensive records regarding
    worksite employees, it has highly specialized personnel dedicated to
    complying with various state unemployment compensation programs. This
    relieves the small business owner of certain recordkeeping and
    compliance burdens, allowing the business to focus on its core function
    rather than monitoring filing deadlines and other compliance oriented
    matters. This arrangement not only reduces the governmental burden of
    collecting unemployment obligations from a myriad of small businesses,
    it also assures consistent compliance with complex unemployment tax
    laws and the timely payment of unemployment taxes--clearly an
    improvement for both PEO customers and state unemployment compensation
    systems. Additionally, since the PEO is collecting and remitting
    unemployment taxes for a larger pool of workers, the PEO is required to
    remit taxes on a more frequent basis than the small or mid-sized
    business client, which serves to boost compliance and to get the
    unemployment taxes into state coffers on a more timely basis.
        Importantly, by providing small and mid-sized employers with human
    resource management services, the PEO relationship reduces unemployment
    compensation claims. It has long been recognized that quality,
    proactive human resource tools, such as accurate job descriptions,
    performance appraisals, and improved employer/employee communications
    can improve employment retention, resulting in fewer unemployment
    claims. In addition, some PEOs have reassigned worksite employees from
    one client to another to minimize unemployment claims, when
    reassignment does not interfere with the business interests of the
    client. Once again, these proactive practices not only reduce claims,
    but, more importantly, result in working Americans retaining gainful
    employment.
        PEOs assist the unemployment system by contesting and documenting
    wrongful claims for unemployment benefits. By delivering these
    services, a PEO helps stabilize unemployment tax rates, thereby
    protecting the PEO's viability in a competitive marketplace and
    eliminating some of the incentive to engage in SUTA dumping.
        We applaud the efforts of the Subcommittees to draw attention to
    the problems caused by SUTA dumping. We encourage the Department of
    Labor and the States to continue to coordinate broad-based efforts to
    deal with abusive situations.
        In closing, we would also bring to the attention of the
    subcommittees PEO legislation introduced by Representatives Rob Portman
    and Ben Cardin--H.R. 2178, the Professional Employer Organization
    Workers Benefits Act of 2003. Although that bill does not directly
    affect SUTA, it would provide small and mid-sized business and PEOs
    with much needed guidance on the intricate web of rules that govern the
    payment of payroll taxes and would create a certification process for
    PEOs dealing with Federal unemployment taxes. Companion legislation, S.
    1269, has been introduced in the Senate by Senator Grassley.