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Taxes, Nannies and Economic Destruction

Thursday, 10 Mar 2011 | 9:32 AM ET

The burden taxes place on employment was recently brought home to me by the experience of a couple I’m friendly with who were trying to hire a nanny to watch their only child.

My friends—lets call them Jack and Jill—figured they could afford to pay about $800 per week for a nanny to work from 8 am to 6pm Monday through Friday. That works out to $16 dollars per hour. For our neighborhood—Brooklyn’s Park Slope—this is about average.

The overwhelming share of nannies in Park Slope work off the books—meaning their income isn’t reported to the government, and their employers do not pay payroll taxes for them. They get a flat sum in cash every week.

Jill happens to be particularly conscientious when it comes to this sort of thing. I suspect it’s because she has ambitions to run for public office. She denies that—which is the clearest sign of someone with political ambitions. Jack is a bit more of an anarcho-capitalist and probably wouldn’t mind depriving the government of some tax dollars—but he also knows better than to cross his wife when she’s got her mind set on things.

Not long into their search for a nanny, they discovered that it is illegal to offer a flat wage of $16 per hour for fifty hours of work. Fair labor laws require them to pay an hourly wage for the first forty hours worked. The next ten hours must be paid at overtime.

In other words, if they offered a nanny $16 an hour, they’d have to pay her $24 for the additional ten hours. That would work out to $880 per week, or 10 percent more than they expected to pay.

Jack’s good with numbers so he quickly figured out that if they offered $14.50 as the regular hourly wage and $21.25 for overtime, they’d be back down to $800 per week. It was exactly the same thing as paying an average wage of $16—but those are the rules.

The taxes presented a more difficult problem. In the first place, it would cost the family $868 to pay someone $800, due to employer side payroll taxes. That’s around 7 percent more than Jack and Jill had planned on paying. The nanny, however, would receive just $613 per week, after federal, state, and city taxes were withheld.

If Jack and Jill really tried to stay within their $800 budget, they could pay a nanny around $736 per week. Payroll taxes bring that up to $800 right away. Instead of earning $16 per hour, the nanny would earn an average of $14.72. Once you figure in withholding, the take home pay hits $569 per week.

Most of us are quite used to the idea that our take-home pay is going to be far lower than the amount our employer is paying us. But try asking nannies working in the largely “off the books” market to accept a $231 pay cut just so that the tax rules are obeyed.

In order to get to the market rate of $800 per week in take home pay, Jack and Jill would have to pay a gross salary of $1071 per week.

After their contribution to payroll taxes, that’s $1,162 per week.

That's the equivalent of being paid $21.42 per hour for 50 hours. It costs Jack and Jill $23.24 per hour once payroll taxes are included.

The nanny's annual income would be a pre-tax amount of over $55,000, and the cost to the family would be over $60,000.

To put it differently, in order to compete with the black-market nanny employers—which is just about everyone else in Park Slope—Jack and Jill would have to shell out 33% more than their less scrupulous friends and neighbors.

To make matters worse, Jack and Jill have to pay that $60,000 out of their own taxable income. Assuming that they pay around 50 percent of their income between payroll, federal, city and state taxes, this means that if either Jack or Jill earn less than $120,000, they’re losing money hiring a nanny. Whoever earns less than $120,000 would be better off just not working.

They get a small tax break—around $600 per year—from the child care tax credit. But that's a rounding error in these numbers.

Let’s take another look at that. Someone who has the skills to command a $100,000 yearly income would be better off not working and not hiring a nanny than paying market rate for a nanny after taxes.

That’s just talent and productivity priced out of the market by taxes.

Now it could be argued that the real problem here isn’t the taxes—it’s all the families and nannies who are dodging taxes. In fact, this is exactly what Jill thinks is wrong.

Arguing about root causes is boring. The fact is that the reality of this interplay between taxes and completely predictable tax-avoidance has made hiring a nanny at market rates on a taxable basis all but impossible for Jack, Jill, and many other couples like them. They’ll likely either have to enter the black market—or have one of them drop out of the jobs economy altogether.

The tax system isn’t a force of nature. It’s just a bunch of rules that we set up. So when we encounter these situations, it’s fair to ask: Is this the way we want the system to work?

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