When I first heard about the hearings, I assumed the phrase “underground economy” related to the practice of hiring workers under the table and paying them in cash. After all, that’s the traditional definition of “underground economy.”

This paper from the Mises organization defines underground economy quite specifically: ‘There is a bustling and shadowy world where jobs, services, and business transactions are conducted by word of mouth and paid for in cash to avoid scrutiny by government officials. It is called the “underground economy,” which is as old as government itself. It springs from human nature that makes man choose between given alternatives. Facing the agents of government and their exactions, man will weigh the alternatives and may choose to go “underground.” ‘

?So I was quite surprised to see that the Senate hearings seemed to have a different focus. The definition of “underground economy” in the Senate hearings seemed to target those who classify someone as an independent contractor, rather than an employee.

According to the statement by Senator John Kerry, Chair of the Senate Committee on Small Business, the definition of underground economy that the Committee is looking at includes small businesses that may misclassify independent contractors instead of employees. Senator Kerry’s statement notes: “Too many workers are being misclassified as independent contractors — an arrangement in which the employer is not responsible for withholding of income or paying employment taxes. Employers who erroneously misclassify their workers stand to save as much as 30 percent of their payroll costs. This puts law abiding employers at a disadvantage.”

I don’t know about you, but I’m troubled by this expansion of the definition of underground economy to include misclassification of independent contractors/employees.

Listen, I’m all for being a law abiding citizen. I wouldn’t dream of suggesting otherwise.

Paying workers under the table in cash, or accepting payment from customers in cash without reporting it is one thing. When you do not report income — either for your own company or for workers — and try to hide your tracks by purposely not keeping a records trail, that’s clearly wrong. It’s black — as in black-and-white wrong. That’s the underground economy. Anyone engaged in it knows it’s wrong.

However, hiring independent contractors can range from lily white to many shades of gray. In many cases it is perfectly legitimate. In fact, it may be the only way that very small businesses can grow. They can’t afford to hire employees, and typically start out with independent contractors.

In other cases, it’s a matter of interpretation. A small business may be reporting all income and all payments made to others, just have a worker misclassified. After all, the IRS requires companies to file 1099-Miscellaneous income statements for any contractor who receives more than $600 in a year. If you are filing 1099s, you are not trying to hide the payments.

You say the worker is in an independent contractor. The IRS says he or she is an employee. The test as to what constitutes an employee and what constitutes an independent contractor is not a clear one, but is open to some interpretation.

You may have misclassified someone. And you may have to pay penalties and make changes because of your error of misclassification.

But does that put you in the same league as an employer who uses illegal immigrants, pays them only in cash to avoid a records trail, and doesn’t report ANY payments at all for that person to the IRS? Should a business owner who legitimately believes someone is an independent contractor but misclassifies the person, be lumped in with those who are deliberately lying to the governmental tax authorities and going to pains to hide it?

I suggest these are two very different behaviors. Let’s not confuse them.

If workers are being paid under the table, in cash, with no records trail and no reporting of those payments to the IRS or to state tax officials, that’s against the law. Often it is undocumented immigrants who are being paid this way. They are being exploited. This is illegal, no question about it.

But I think it’s a different issue to start labeling hard-working business owners who are doing their best to interpret unclear rules as “cheaters.” If you do that, then you could drive businesses deep underground and off the books and into the REAL underground economy — businesses that otherwise would not want to be off the books. Or you’ll cause them to forgo growing and getting help for their businesses, and that won’t help the economy one bit.

What’s your view? Should small businesses using independent contractors and who report the payments they make to them, be lumped in with those who pay under the table and try to hide their payments? Is there a difference?