This chapter provides background on the rise and growth of the employee leasing industry as well as early responses to the increased presence of the industry within the contingent worker segment of the labor force.
Employee leasing had its origins in the differential pension treatment of different classes of employees, in which one group of employees (generally officers) had a more generous pension program than other employees. Because the higher pretax contribution to the pension fund represents tax avoidance, the Internal Revenue Service (IRS) generally requires that all " employees" be eligible for the same pension plan. If, however, one group of workers could be considered employees of the firm and another group employees of the leasing company, this could accomplish the same end.
The first leasing firm was said to have opened in California in 1972,1although others cite the leasing of Pinkerton security guards in the 19th century as the origins of employee leasing. Although its origins may be disputed, the growth in employee leasing is consistently linked to employee pensions.
Historically, many small business owners have maintained pension plans as a way to defer income for themselves and other employees. Participation in these pension plans was often limited to selected key employees. As these plans were seen as both discriminating against the nonkey employees of the business and as a means of deferring or avoiding income taxes, the IRS established a set of guidelines in 1982 to require employers to cover a substantial portion of their employees under the pension plans.
Many methods were used by employers to avoid the antidiscrimination laws. For example, some small business owners instituted lengthy vesting schedules in order to exclude all but long-term employees from becoming vested in their pension plan. Another tactic undertaken by small employers was to separate employment of highly compensated employees from that of the rest of the firm. One way that this was accomplished was by firing the firm's rank-and-file employees and then leasing them back from a leasing firm.
In order to stem these abuses, Congress passed the Employee Retirement Income Security Act (ERISA) in 1974 Public Law 93-406. ERISA instituted the test of common control. Under this test, if two organizations had substantial common ownership, then the employees of both organizations were to be treated as if they were employed by one employer. In the case of leasing companies, however, if the common control test was not violated, the leasing company was considered the employer for pension purposes.
The next major piece of legislation to try to deal with employee leasing was the Tax Equity and Fiscal Responsibility Act (TEFRA) of 1982, Public Law 97-248. TEFRA was the first piece of Federal legislation that specifically referenced leased employees. It stated that employers, partners, or other high-paid employees of a company could not be provided a different pension plan than other employees and further clarified that leased employees were to be treated as employees of the client company unless safe harbor provisions were met.
TEFRA's safe harbor provisions2 provided an escape route for employers desiring different pension plans. This section stated that leased employees are not subject to the same pension rules if the leased employee is covered by a plan maintained by the leasing organization that allows for immediate participation, full and immediate vesting, and employer contributions of at least 7.5 percent of the employee's salary. By meeting the provisions of the safe harbor section, employers could turn their employees over to a leasing company and provide pension plans with larger tax advantages to partners and other high-paid employees. These pension tax advantages, coupled with the savings in personnel management costs, proved to be very attractive and are often attributed with the growth of the employee leasing industry from only 5 firms3 with fewer than 5,000 employees prior to the enactment of TEFRA4 to an industry where 75,000 people worked under leasing arrangements in 1985.5
The Tax Reform Act (TRA) of 1986, Public Law 99-514, amended this tax shelter feature that allowed employers to offer pension plans to partners or high-paid employees with greater tax advantages. To qualify under the safe harbor provision as amended by TRA, leasing companies now are required to offer a pension plan that provides a 10-percent employer contribution to all employees of the leasing firm earning $1,000 or more annually.
Additionally, IRC§414(n)(5)(A) states that the safe harbor provisions do not apply if leased employees constitute more than 20 percent of the recipient's nonhighly compensated workforce.6
The changes enacted by TRA have virtually curtailed the use of safe harbor provisions to achieve the tax advantages previously associated with employee leasing. The leasing industry, however, continues to grow.
Since TRA, industry growth has been fueled by increases in employee benefit costs, particularly health insurance and workers' compensation premiums, both of which represent a larger share of the nonwage labor cost than UI. Thus, it should be kept in mind that the impetus for employee leasing may lie elsewhere, but the UI system is being affected as a result of these changes in labor market organization.
One of the financial incentives motivating employers to use employee leasing is the growing importance of fringe benefits as a component of labor compensation. This trend is apparent in data from the National Income Accounts (NIA) and in data from the Employment Cost Index (ECI) survey. In the NIA data, fringe benefits (employer contributions for social insurance and other non-labor compensation) grew from 5.0 percent of employee compensation in the year 1950 to 17.3 percent in 1992.
The ECI, an establishment-occupation based survey, has tracked wage and fringe benefit growth among private nonfarm employers since 1980. Fringe benefit costs grew faster than wages in every year between 1980 and 1992 except 1985. Over these 13 years, the annual average growth rates were 5.2 percent for wages and salaries and 6.6 percent for fringe benefits a 27-percent higher growth rate for fringe benefits. From 1993 to 1995, fringe benefits as a percent of total compensation declined by 1 percent to 28.4 percent of total compensation.
Within the detailed categories of fringe benefit costs, the employer costs of both Federal and State UI payroll taxes are identified. Combined, these UI taxes decreased from 1.1 percent of total compensation in March 1987 to 0.9 percent in March 1995. Thus, UI payroll taxes have not been growing as a share of employee compensation among private industry employers.Exhibit 2-1 indicates that the six categories of fringe benefits representing the largest costs to employers in March 1995 were (in descending order) health insurance (6.2 percent), Social Security taxes (6.0 percent), vacation pay (3.1 percent), pensions and workers' compensation (each 2.3 percent), and holiday pay (2.2 percent). Combined Federal and State UI taxes among private industry employers (0.9 percent) were similar in magnitude to nonproduction bonuses (1.3 percent), premium (mainly overtime) pay (1.1 percent), and sick leave (0.8 percent).
Unemployment Insurance Service
Department of Labor
Employer Costs Per Hour Worked for Employee
Compensation and Costs as a Percent of Total
Compensation, Private Industry, March 1995
|Compensation||Total Private||1-99 Workers||100 workers or more|
|Wages and salaries||12.25||71.6||10.81||74.1||13.58||69.9|
|Sickness and accident||0.04||0.3||0.03||0.2||0.06||0.3|
|Retirement and savings||0.52||3||0.33||2.3||0.69||3.5|
|Savings and thrift||0.13||0.7||0.08||0.6||0.17||0.9|
|*Cost per hour worked is $0.01 or less.|
|SOURCE: Bureau of Labor Statistics. Employer Cost Indexes and Levels, 1975-95. October 1995,|
|Bulletin 2466, Table 18.|
For small employers (those with 1 to 99 employees in published ECI tabulations), the legally required payments represent a larger share of total compensation: 10.1 percent in March 1995 compared to the all-employer average of 9.3 percent. The higher percentage for small employers is probably due to their below-average wages (coupled with a fixed tax base for UI and Social Security taxes) as well as higher average rates for workers' compensation. Health insurance costs are actually a below-average percentage of payroll for small employers, but the explanation here is undoubtedly that many do not provide any health insurance. Among those who provide it, health insurance is an above-average share of employer costs. Unfortunately, this cannot be discerned from the survey results.
From the preceding, it is apparent that fringe benefits have come to constitute a very large component of employer labor costs. Fringe benefit costs as a whole have been growing more rapidly than wages and salaries. A sizable share of fringe benefit costs are mandated payroll taxes. These taxes are more important in the cost structure of small employers than other employers. Finally, UI taxes represent only a modest share of fringe benefit costs. Health insurance and workers' compensation premiums represent a larger share of nonwage labor costs than UI. However, although the impetus for employee leasing may lie elsewhere, the UI system is being affected as a result of these changes in labor market organization.
Leased employees traditionally have been considered within the larger category of contingent workers, a group that is broadly defined by employment arrangements that differ from regular full-time, permanent, wage-and-salary positions.7 Corporate downsizing and worker dislocation have increased the use of nontraditional employment arrangements. Workers who usually fall into this category include part-time, temporary, and contract employees; those who are self-employed; workers from the business services sector; and leased employees8. Based on a supplement to the February 1995 Current Population Survey (CPS) questionnaire, there were 6.034 million contingent workers under the definition that would include leased employees out of a total workforce of 123 million workers over the age of 16.9 Leased employees, however, should be considered a unique subset of contingent workers: they usually have full-time positions, are more likely to have long-term employment arrangements, and receive higher wages and more complete benefits than other contingent workers. Measured differently, an estimated 652,000 workers in the CPS supplement were provided by contract firms.10 For a number of reasons, this may be expected to be both an overestimate and underestimate of leased workers.
Leasing firms were classified in Standard Industrial Classification (SIC) 7369 (Personnel Services, Not Elsewhere Classified) in County Business Patterns (CBP) data under the 1972 industrial classification system. 11 In March 1979, this industry had 450 establishments and 47,285 workers. The number of workers dropped from 45,137 in 1982 to 31,359 in 1983, and the number of establishments decreased from 438 to 383, presumably the result of changing ERISA regulations governing safe harbor leasing under TEFRA.
After 1983, the number of employees again grew and reached 45,122 in 1987, the last year firms were classified under 1972 SIC codes. This estimate is lower than suggested by the tone of public discussions about employee leasing from the early to mid-1980's. These low national totals in CBP data could be partially due to the misclassification of some leasing companies into SIC 7362 (Temporary Help Services). During the 1979 to 1987 period, average employment of establishments in SIC 7369 (Personnel Services, Not Elsewhere Classified) remained in the 105,000 to 115,000 range.
After 1987, leasing firms were reported along with temporary help agencies within SIC 7363 of the revised SIC system. SIC 7363 (Help Supply Services) had 1,075,730 workers in 1988, compared to 800,227 for the temporary help industry alone in 1987. Although it is not known what percentage of the additional 275,503 employees worked for employee leasing firms, it is possible to estimate the proportion based on data on the growth of temporary workers. Temporary help employment grew by more than 100,000 in the 3 years prior to 1987. Thus, it seems likely that more than half of the 275,503 increment from 1987 to 1988 is due to growth in temporary help employment.
The combined SIC 7363 (Help Supply Services) has continued to show employment growth since 1988. By 1990, the latest year of available CBP data covering all States, the national total was 1,210,312.
A recent estimate of employment available using the Employment Service (ES) 202 data is for employment during 1994. During this period, 23,531 Help Supply Firms (SIC 7363) reported activity. They reported aggregate employment of approximately 2 million workers. BLS currently has a project underway to distinguish temporary help agencies from Employee Leasing firms within SIC 7363 (Help Supply Services). The BLS project had separated most of the reporting units into the two categories by late November 1993. In June 1992, there were 20,408 reporting units in SIC 7363. The breakdown by type of firm was as follows: 2,006 leasing companies, 11,332 temporary help firms, 6,922 not yet classified, and 148 not leasing companies or temporary help firms. The latter are apparently reporting units with inappropriate industrial classifications. The associated employment counts were as follows: 1,469,559 total, 188,593 leased employees, 1,024,753 temporary help employees, 238,882 not classified, and 17,331 employees in firms not classified appropriately. Thus, of the workers classified as either leased or temporary help, leased employees made up 15.5 percent of the total (188,593 of 1,213,346).
The ES 202 reporting system adopted the 1987 SIC codes in 1988. Therefore employees in leasing firms are classified in SIC 7369 prior to 1988 and in SIC 7363 from 1988 to the present. A tabulation of ES 202 data showed that in March 1987 (under 1972 SIC codes), there were 879,220 workers in Temporary Help Services and 71,329 in Personnel Supply Services, Not Elsewhere Classified (SIC 7369). This count in SIC 7369 exceeds by 58 percent the corresponding count in CBP data.
Under current SIC codes, total employment in SIC 7363 was 1,065,919 in March 1988. This combined total for the temporary help and leased employment classification had grown to 1,293,091 by March 1992. For March 1990, where national totals can be compared with CBP data, the two data sources showed very similar employment totals: 1,247,432 in ES 202 data and 1,210,312 in CBP data, a difference of 3.0 percent.
The ES 202 reporting system requests that employee leasing firms report employment in each of its client firms using a Multiple Worksite Report form, as well as total employment and central office employment. Compliance with this requirement is spotty. Another outcome expected from the BLS project mentioned above is to generate estimates of the number of leasing firms and the associated employment that is reported solely in SIC 7363 (Help Supply Services).
In States that have special registration requirements for leasing companies (for example, Florida), the universe of actual and potential leasing companies among active employers is known, making the problem of identifying employee leasing firms and employees greatly simplified. Unfortunately, not all States compile these lists. This makes it impossible to generate reliable national estimates based only on this source of data.
As a result of the inability to produce reliable estimates of the size and characteristics of the employee leasing industry, one of the objectives of this study was to attempt to do this utilizing a survey of State UI Agencies. The results of this survey are provided in the next section of this report.
1 Howard Potter. "Getting a New Lease," Management Review." April 1989, p. 30.
2 IRC§ 414 (n)(5).
3 James R. Redeker and James O. Castagnera. "The Legal Nightmares of Employee Leasing." Personnel Journal. February 1985, pp. 58-62.>
4 Thomas A. Ulrich and Charles J. Hollon. Business; October to December 1988, p.44.
5 Kenneth Traynor and James G. Pesek. "Implications of Employee Leasing for Small Business," Journal of Small Business Management: October 1987, p. 10.
6 Nonhighly compensated employee is defined
7 Richard S. Belous. The Contingent Economy: The Growth of the Temporary, Part-time and Subcontracted Workforce.National Planning Association, Washington, D.C. 1989.
8 U.S. Congress. Senate. Committee on Labor and Human Resources. Subcommittee on Labor. Hearing on Toward a Disposable Workforce: The Increasing Use of "Contingent Labor." 103d Cong.,1st sess.,1993.S.Hrg.103-620.
9 U.S. Bureau of Labor Statistics. Contingent and Alternative Employment Arrangements, Report No. 900, USDL 95-318, August 1995, Table 1.
10 Ibid., Table 5.
11 It is more accurate to state that most leasing firms are classified in this four-digit industry. When 1972 SICs were first assigned in the early 1970s, there were no leasing firms. When leasing came into existence, the firms were encouraged to report in SIC 7369, but many may have reported in SIC 7362 along with Temporary Help agencies.