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Why Turning Contractors Into Employees Hurts Everyone

A California court decision could harm not just businesses but also workers and consumers. And the misguided idea shows signs of spreading to other states.

aerial view of construction worker in construction site
When the California Supreme Court decided to introduce a new test to determine whether workers should be classified as employees instead of independent contractors, the immense costs the decision would create for businesses were immediately clear. Forced worker reclassification for a large swath of the economy -- including everyone from janitors to gig economy workers -- poses a direct threat to many long-standing business models.

Lost in the shuffle, however, has been the reality that workers, consumers and society itself would also feel the harmful impact of the court's ham-handed attempt to change worker status. And the damage could extend well beyond California.

Last year's ruling in a lawsuit by courier drivers for Dynamex Operations West Inc. held that workers were presumed to be employees of a firm, and therefore entitled to the benefits attached to employees, unless the firm could demonstrate otherwise. To do so, the court laid out what has become known as the "ABC Test," requiring that independent contractors (A) must be outside the firm's control while performing their jobs; (B) must be performing a task outside the firm's normal scope of business; and (C) must have made a definitive decision to go into business for themselves.

Based on the ABC Test's broad language, thousands of people who have traditionally been classified as contractors -- such as insurance and real-estate agents, construction workers, personal trainers and gig economy workers -- could be converted to employee status. The costs would be immense. Our organization's analysis estimates that if the Dynamex decision is applied broadly or is codified into state law, Golden State businesses could face additional payroll expenses of as much as $6.5 billion annually.

Yet these costs capture only a small portion of the potential harm. Despite misguided claims to the contrary, it's long been clear that most workers who become freelance contractors or join gig economy platforms do so to smooth income volatility. They are facing unexpected large expenses or a sudden reduction in household income and thus are seeking to supplement their earnings by, say, being a food deliverer or a rideshare driver.

These workers operate as so-called "threshold earners," in that they are trying to achieve a certain amount of earnings and then stop. Rather than seeking to become gig workers for life, then, most of them use such platforms to temporarily supplement income. At a time when the majority of Americans say they would struggle to pay even a $500 car-repair bill, the ability to find quick additional earnings is vital to many people's way of life.

Forcing contracting firms to reclassify workers as employees would make this quick access to supplemental income more complicated. As it stands, finding ready income can be as easy as switching on an app -- a model that benefits both workers and consumers, as a flexible labor supply makes it easier to meet unexpected periods of customer demand. But converting these workers to employees would mean they suddenly could qualify for overtime, forcing businesses to turn to complicated shift-scheduling systems.

This would mean that workers could not necessarily choose when they wanted to work and that firms would no longer be able to match periods of increased demand with more workers, both of which are key benefits of the on-demand economy. So, for example, a single mother who wants to spend a few hours a night as a gig economy worker might no longer have that option. The forced conversion of workers from 1099s to W-2s would have other perverse policy consequences. It could, for example, affect unemployment insurance eligibility as well as a worker's ability to deduct businesses expenses for taxes.

While some might be tempted to chalk off these issues as an only-in-California problem, the reality is that reclassification efforts have already started spreading to other states. Lawmakers in Washington state, for example, are considering legislation that would embed an ABC Test in its labor laws. California, which is so often seen as a policy bellwether, could set off a wave of forced worker reclassification across the country.

There are better policy alternatives that could provide a safety net for workers while maintaining their flexible status. Perhaps the most promising idea is a flexible "third-way" status that would create a new category of worker -- something between an independent contractor and an employee. This status could be coupled with a flexible benefits package that would provide workers with a variety of non-cash benefits more traditionally associated with salaried employees.

Although the details of such a third-way status would need to be hashed out among lawmakers and other policymakers, it's clear that modernizing labor law this way would be a much better answer than forcing 21st-century labor markets to march down the road of forced reclassification. Nuanced public policy issues deserve nuanced answers -- not poorly thought-out ideas that just create more problems.

Director of commercial freedom policy at the R Street Institute
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