Since the turn of the twenty-first century, independent workers have become an increasingly important part of the modern American economy as workers choose flexibility over traditional “9 to 5” employment. This trend is most clearly evidenced by the substantial growth in the numbers of Americans participating in the gig economy. In 2005, Intuit estimated only 10.3 million Americans were independent workers. That number had grown to 59 million by 2019 with independent workers making up 36% of the total U.S. workforce and generating $1.2 trillion in earnings.
Despite the importance of independent workers to the U.S. economy, the federal government had, until recently, failed to provide enough clarity as to what constituted an independent contractor or employee under the Fair Labor Standards Act. The failure of the federal government to accurately define the status of independent workers has allowed states, led by California, to impose draconian legislation that will destroy independent workers.
The federal government’s lack of clarity all changed when the Department of Labor issued a new rule on Wednesday that not only protects the ability of independent workers to participate in an employment structure, it also provides businesses the confidence they need to hire temporary labor to support their continued growth. According to the Bureau of Labor Statistics, 79% of independent contractors prefer independent employment arrangements over traditional jobs.
Previously, the federal government only issued limited guidance on the status of independent contractors. The Internal Revenue Service, for example, only defined them as someone who is not controlled by an employer and someone who has control over how the service is provided. As the IRS notes, this is only a general rule and did not allow companies to correctly classify workers.
This lack of clarity was particularly harmful to smaller businesses that required staff to grow but often could not afford to meet the high costs associated with hiring and maintaining full-time employees. In terms of salary and benefits, the Small Business Administration estimates employees cost employers around 1.25 to 1.4 more than independent workers.
To correct this, the DoL issued a new rule that not only clarifies the difference between an employee and independent contractor, it also creates confidence that businesses are correctly classifying their workers as well as allows independent workers the ability to participate in an employment structure they overwhelmingly want.
The new rule has four components to determine whether an individual is an employee or an independent contractor. The first employs an economic reality test to determine whether “an individual is in business for himself or herself or is economically dependent on a potential employer.” The second explores “two core factors” such as “the nature and degree of control over work and the worker’s opportunity for profit and loss.” Finally, the new rule seeks to identify “the amount of skill required for the work,” the “performance of the working relationship,” and whether “the work is part of an integrated unit of production.”
The new rule has received significant praise from business groups, with the U.S. Chamber of Commerce stating the new rule will give “employers and employees greater clarity, and providing a modern interpretation of what it means to be an independent contractor.”
The DoL’s new rule also represents a much better policy alternative than the PRO Act or California’s AB-5. Unlike the DoL’s flexible approach to independent contractors, the proposed PRO Act and AB-5 would impose an onerous three-pronged test that would effectively eliminate the use of independent contract labor.
Under the PRO Act and AB-5, employees would be subjected to an ABC test that only allows individuals to be considered as independent workers if they are “free from the control and direction of the hiring entity…. performs work outside the usual course” of the business’s operation, and the individual is “customarily engaged in an independently established trade…of the same nature as that involved in the work performed.”
Studies showed that, if the PRO Act became federal law, American businesses would see “between $3.6 billion and $12.1 billion in additional costs to businesses” and the law could cost the U.S. economy 8.5% of its GDP. The gig economy would suffer. Simply put, neither American businesses nor the wider economy can afford such a rigid definition of independent contractors. While the rule has been published, there is significant risk that the incoming Biden administration will not allow the rule to take effect. Failure to allow the rule to come into force will not only prevent independent workers from participating in an employment structure they overwhelmingly approve of, but it risks continuing uncertainty for businesses as they seek to grow.
This article was published in The Economic Standard.