This week, the California legislature is poised to pass one of the most significant pieces of labor legislation in recent decades. While the details of Assembly Bill 5 (AB5) may seem arcane—it imposes what is known as the “ABC test” to determine the classification of a worker as an independent contractor or employees—the consequences are far-reaching for the structure of the economy in California and the nation.
Why Worker Classification Is So Important
Worker classification refers to whether an individual is considered—and paid—as a wage and salary worker, or as an independent contractor. Wage and salary workers (sometimes known as W-2 workers, because their income and payroll taxes reported through an IRS W-2 form) are covered by a wide array of labor laws, such as the minimum wage, anti-discrimination laws, and laws supporting the right to join a union, and are covered by a wide range of social insurance protections, such as unemployment insurance if they lose their job, workers compensation if they are hurt on the job, and Social Security retirement and disability benefits. In contrast, independent contractors (often known as 1099 workers, because their income—and only their income—is reported through an IRS 1099 form) are considered in business just for themselves, and thus are written out of nearly all labor laws and social insurance programs. Not only do independent contractors lack these workplace protections, they frequently wind up, in the end, working for less pay: not only must independent contractors pay income taxes, they also must pay double what wage and salary workers pay in payroll taxes—once for the “employer’s” portion, and once for the “worker’s” portion.
Independent contractors are written out of nearly all labor laws and social insurance programs.
The independent contractor arrangement may make sense for lawyers, accountants, and other similar professionals—they can bill high enough hourly rates to account for the larger tax bite—but it can be a bad choice for lower-wage workers. But since companies can save as much as 30 percent of payroll taxes by paying workers instead as contractors, they have a huge incentive to misclassify those who should be paid and protected as workers. Depending on the state, between 11 percent and 30 percent of all employers misclassify parts of their workforce. Misclassification has become rampant in sectors such as transportation, janitorial services, home care, and construction. A Massachusetts study found that between 14 percent and 24 percent of companies committed misclassification, and in these companies, 40 percent to 48 percent of workers were misclassified. In California alone under existing laws, state agencies found a half million misclassified employees in 2017. Janitorial companies like Coverall have even forced contract workers to pay thousands of dollars in franchise fees for the privilege of cleaning buildings, often resulting in these workers receiving subminimum wages. Delivery companies like FedEx and port operators have forced truck drivers to work as independent contractors—and shoulder the heavy business expenses that come along with it—despite tightly controlling their work schedules and the price they can charge for their services.
The Gig Economy Has Raised the Stakes of Misclassification
The rise of gig economy firms such as Uber, Lyft, Doordash, and Handy has put worker misclassification in the headlines, and in the middle of the 2020 presidential race. These companies have positioned themselves as technology platforms that allow workers the flexibility to work when and how they want. They have argued that it is labor law that needs to change to match the innovation and services they provide, perhaps with a new legal category that fits their business model of “independent workers.” Uber and Lyft think of this class of workers as existential to their business models, going so far as to issue major warnings in their IPO stock offerings about the threat of regulation. In contrast, labor experts have pointed out that these workers aren’t really “independent,” because app-based platforms tightly control their work, don’t give them any entrepreneurial authority to set their own prices, and can even kick them off their platforms for minor rule violations, with no recourse.
Dynamex Court Decision Changes the Term of the Debate
While Uber and Lyft have already been subject to numerous lawsuits, it was a class-action suit brought against the on-the-ground delivery service company Dynamex that fundamentally changed the policy debate about misclassification. In 2004, Dynamex reclassified its delivery drivers as independent contractors, and in response, the workers sued, with the case making its way to the California Supreme Court. In a decision in favor of the drivers, the court not only ruled that these workers were misclassified according to California wage laws, but also said that all California employers should be subject to a simple, straightforward employment classification test, known as the ABC test. This test determines that a worker is considered a wage and salary employee, unless all three of the following conditions apply:
- that the worker is free from the control and direction of the hirer in connection with the performance of the work, both under the contract for the performance of such work and in fact;
- that the worker performs work that is outside the usual course of the hiring entity’s business; and
- that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as the work performed for the hiring entity.
The ABC test limits the independent contractor status to the common-sense idea that contractors are specialists in business for themselves that companies hire for specific tasks outside of their regular business. The B part of the test is particularly critical for digital gig economy companies. While these employers argue that they operate as technology platforms that connect consumers and drivers, courts using the ABC test are far more likely to look at them as transportation companies that derive earnings from their drivers’ labor. That’s the view that a British court took when they concluded that drivers worked for Uber in their delivery of transportation services in London. And the potential impacts of the decision reach far beyond the gig economy: not only are delivery drivers now considered as wage and salary workers for a company like Dynamex, but also for FedEx; home care workers working for home care agencies janitors at cleaning companies, and so on.
AB5 Codifies the Dynamex Decision
California Assembly Bill 5 codifies the Dynamex decision into state law, establishing the ABC test for employees for California’s labor and unemployment insurance laws. The bill provides numerous exemptions to the new more stringent ABC test for occupations such as real estate agents and other direct salespersons; doctors, dentists, and other professionals; and a smattering of other occupations, such as barbers and cosmetologists (but, through the result of organizing, not manicurists). Nonetheless, AB5 would signal a major change for employment law in the largest state economy in the nation. Despite numerous efforts by gig economy titans to negotiate an exception for themselves in AB5, the bill appears poised to pass the legislature before the session ends on Friday. It has already passed the Assembly and the powerful Senate Appropriations committee, and Governor Newsom announced his support over the Labor Day weekend. If enacted, California would become just the fourth state to implement the ABC test for wage and hour laws, and would join about half of the other states that use ABC for unemployment insurance.
Political Shift against the Gig Economy
The progress of AB5 represents a remarkable turnaround in political attitudes to gig economy firms from the home state of many of its industry’s largest leaders. In recent years, gig economy firms had successfully convinced multiple state legislatures to carve them out of standard worker definitions, creating a threat not only to those who currently work for platform companies, but also to those who work for other companies that could easily mimic the gig economy business model. But, in a turnaround that foreshadowed the decision in California, New York City implemented a cap preventing the addition of new gig economy drivers—just a few years after a similar proposal by New York City Mayor Bill Deblasio was defeated—and imposed minimum fare rules. The Los Angeles group Rideshare Drivers United organized multiple drivers strikes against Uber and Lyft, demanding a $28 minimum wage and recognition of an independent, driver-led union. In that context, these companies’ compromise proposal of a $21 per hour minimum wage and a bargaining proposal short of full labor rights fell flat in Sacramento. While gig economy companies argue that employee status will undermine the flexibility of those who work on platforms, Nicole Moore of Rideshare Drivers United told me that, when it came to gig employers, “all they want is the flexibility to pay you less.” The argument from her and others is holding sway: all of the major Democratic presidential candidates except Joe Biden have come out publicly in support of AB5.
What Comes Next
AB5 won’t be the final salvo in the war over worker classification in the gig economy in California. The impact of the standards in AB5 will largely turn on the way in which they are enforced, as targeted enforcement by state labor and tax agencies is far more effective at bringing systemic change than any agency response to individual complaints. The platform corporations Uber, Lyft, and DoorDash have pledged $90 million to a ballot initiative to bring their counterproposal to voters and have pledged to continue litigating worker classification cases in the state. And the California State Senate president indicated that she will continue to be open to further legislation in coming years about the status of different professions impacted by AB5.
But what if the reach of AB5 were to force gig economy platform to eat the extra costs and the business changes necessary for complying? One analyst concludes that they could use the advantages of technology to deliver ride-sharing (and other services) to consumers, but with a smaller number of workers, each working more hours—in essence acting more like a mature company than a world-changing disrupter.
While the fate of gig economy firms is uncertain, the passage of AB5 is likely to catch the attention of other states looking for ways to legislate against wage inequality. Laws like AB5 have the advantage not only of bringing a host of worker protections to the workforce, but also delivering more tax revenue into state and federal coffers—something that many states are looking for right now. And national change might not be far behind, as the signature labor law reform bill (the PRO ACT) in Congress would enact an ABC test for the purpose of labor law. AB5 may be just the latest wave of newfound attention for the role of labor law reform as a force for progressive economic change.
cover photo: Rideshare drivers wave flags and hold signs during a protest outside of Uber headquarters in San Francisco, California. Source: Justin Sullivan/Getty Images