Late Tuesday evening, the California legislature passed controversial legislation that would codify a state Supreme Court decision, which adopted a flawed test that effectively prohibits companies from doing business with independent contractors and restricts individuals’ ability to earn a living as an independent contractor. Many of the estimated two million independent contractors in California, representing about 10 percent of the state’s workforce, will be considered “employees” as a result of the legislation. And with the public approval from California Governor Gavin Newsom, it will likely become law soon.
Assembly Bill 5 would codify what is known as the “ABC” test that is used to determine whether an individual is an “employee” or “independent contractor.” Under such a test, there is a presumption that all individuals hired to perform a service are employees. The only way it is permissible to classify an individual as an independent contractor is if the hiring company can demonstrate the worker satisfies all three parts of the ABC test. The three-part test requires:
(A) 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 the work and in fact; and
(B) that the worker performs work that is outside the usual course of the hiring entity’s business; and
(C) that the worker is customarily engaged in an independently established trade, occupation, or business of the same nature as that involved in the work performed for the hiring entity.
Such a test is nearly impossible to satisfy, and would make “employee” the default classification of workers in the state of California. Part “B” and “C” of the test are especially problematic and difficult to satisfy.
Gig economy companies in particular will struggle to satisfy part “B.” Is Uber a technology/software or transportation company? For the purposes of satisfying the ABC test, the answer to this question is of the utmost importance. If Uber is considered a tech company that created an app that acts as a marketplace that connects drivers and riders, then its drivers may satisfy part “B” and remain independent contractors. On the other hand, and the more likely scenario, Uber will be considered a transportation company. As such, it would be hard to argue that drivers are performing work that is outside the usual course of business.
Satisfying Part “C” will be problematic for any employer seeking to hire an independent contractor. How would a company hiring an independent contractor know if they regularly perform their trade for other clients? A company hires an independent contractor to perform a job, not to learn about their day-to-day activities.
Another problem with Part “C”, as noted in a recent Competitive Enterprise Institute report, is that it “fails to consider the burgeoning class of entrepreneurs who work as independent contractors only to earn supplemental income. These individuals might choose to work for only one client. Such an individual who operates with complete autonomy—and clearly qualifies as an independent contractor under a common-law test—could nonetheless fail an ABC test because the individual chooses not to actively market the individual’s services to others but is content to limit his or her work to one company.”
So, why is the California legislature seeking to effectively ban independent contracting by imposing a test that makes everyone an employee?
First (and the primary reason) is that the legislation says that independent contractors lose out on many workplace protections—minimum wage, overtime, and ability to unionize. It is not that the California legislature is concerned about these workplace “protections,” but that only employees may unionize. In contrast, independent contractors are essentially small business owners and the law prohibits companies from banding together and fixing prices. In short, AB 5 is payback to labor unions for their support over the years.
Second, the bill pronounces that the “misclassification of workers as independent contractors has been a significant factor in the erosion of the middle class and the rise in income inequality.” This is an unfounded statement not backed up by any facts. A recent study by MBO Partners finds that “Some 3.14 million Full-Time Independents [workers], about 20 percent of the total, earn more than $100,000 per year.” In addition, the same study finds half of all independent workers feel more financially secure as independents than traditional employees.
Another study conducted by Upwork and the Freelancers Unions finds the number of high-earning freelancers is growing. Freelancers earning less than $75,000 in 2014 was 83 percent. In 2018, that number declined to 69 percent.
Further, Census Bureau data contradicts the rising income inequality trope. American Enterprise Institute scholar Mark Perry displays as much in three charts using the Census data. In summary, the middle-class is shrinking, but because U.S. households are getting richer, not poorer.
In summary, the California legislature’s rationale for passing AB 5 is bogus. It is political payback that limits all individuals right to earn a living as they see fit. And more and more individuals value the flexibility inherent to independent contract work and voluntarily choose to work as independent workers on a full-time basis.
This legislation is also severely shortsighted. In the last recession, many individuals found refuge as independent contractors when they lost their job and could not find traditional employment. “Between 2010 and 2014, independent contractors grew by 11.1 percent (2.1 million workers) and represented 29.2 percent of all jobs added during that time period,” according to a report by the American Action Forum and Aspen Institute. Further, during a recession or thriving economy, work as an independent contractor offers opportunity for the unemployed to make a living while they search for a new job. With AB 5, there will be no independent contractor jobs to go to.