[House Hearing, 108 Congress]
[From the U.S. Government Printing 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 
[email protected], 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 
[email protected], 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.