The On-Demand Economy: Revising the Rules For Independent Contractors

The on-demand economy is booming.

Nearly 50 million Americans now self-identify as independent professionals in some form or fashion, and market analysis indicates that figure will continue to grow in the coming years. According to PwC, global revenues in the on-demand economy may hit $335 billion by 2025.

There’s a reason the on-demand economy is flourishing: It enables both workers and businesses to be more flexible, and therefore enables capital and time to be allocated more efficiently.

2 issues with current labor laws

However, this new economy is being held back by an uncertain regulatory environment, which is also producing concerns and fears for many workers.

Our current labor laws were written in an age when there was a clear imbalance of power between companies and workers. The call to regulate the labor markets and offer protection for workers was delivered through an aggressive legislation process, centered around the Federal Insurance Contribution Act (FICA) of 1935 and the Fair Labor Standard Act (FLSA) of 1938. This legislation set into law a so-called “social safety net” that encompassed protections such as minimum wage, overtime payment, unemployment insurance and workers compensation.

Today we are faced with a vastly different labor landscape. The biggest consequence of the regulatory framework for the on-demand economy is the confusion in the classification between employees who are covered by the social safety net, and independent contractors who are not.

This set of circumstances creates two significant problems:

  1. Mistreatment of some workers —Many workers are being misclassified by companies as independent contractors, while in reality they function as full-time employees. Some companies do so innocently; others misclassify deliberately to avoid tax and benefit payments required for full-time employees.
  2. Loss of federal revenues — There are billions of dollars lost every year in federal taxes, and even more in state taxes, due to misclassification of workers as independent contractors. This is due to three factors:
    1. Unrecorded income earned by independent contractors;
    2. Lower payroll taxes that independent contractors remit; and,
    3. Expenses that independent contractors can write off against income.

It’s time to modernize labor laws that are specifically tailored to the nuances and complexities of today’s new economy.

Two types of independent contractors

In better understanding this debate, we need to acknowledge that certain factors, like the ubiquity of information, telecommuting, the pace of innovation and the paucity of certain skills have led to a shift in power between workers and companies for some segments of work.

Today, there are really two distinct types of independent contractors:

  1. High income independent contractors, such as engineers and designers, who are well compensated and even sought-after, and are better able to protect themselves from rogue employers by acquiring benefits and desired security.
  2. Lower income independent contractors, who work in fields like construction, wellness and repair. These workers have less security, less income and therefore may need government-provided benefits and protections to help them.

Legislative options on the table

Legal scholars, politicians and economists have already begun calling for new reform as it relates to inadequate labor legislation. Sen. Mark Warner, D-VA, has called on his colleagues in Congress to create a social “safety net” to protect this new class of on-demand workers. The most practical and most-discussed models are:

  • A dependent contractor model. In addition to the two definitions of U.S. workers already provided today — the full time employee (W-2) and the IC (1099) — a new worker definition would be created, called the dependent contractor. Creating this category would provide lower income workers with the protections they need, while allowing high income workers the option to remain as independent contractors.  The dependent contractor features portability of benefits, ownership of digital records and adjustment to the Self Employment Retirement Plan. In exchange the dependent contractors would give up his ability to write off his business expenses against his income.
  • The Pro-Rata Tax Solution/Hour Bank. Two similar proposals revolve around an hourly breakdown. The Pro-Rata Solution has employers paying the fraction of the burden per the work performed — 30 percent of time yields 30 percent of the tax and benefits. With the Hour Bank both the employer and the IC would pay into fund managed by a third-party. The independent contractor’s hours would be tracked and he or she would be able to draw from this fund in proportion to the hours worked, no matter the employer.
  • The independent contractor inclusion in the legislative system.  Independent contractors were not contemplated and thus not included in the legislation. This created a gap of a class of people who are not covered by the labor most important laws. Simple amendments to these laws can include independent contractors as well as giving agencies like the EEOC and NLRB the ability to regulate them in addition to full time employees.

Our proposal for modern labor legislation

While the three policy recommendations outlined above certainly have merit, they’re not designed in a manner that would make them viable legislative solutions. These suggestions are trying to fit old economic structures into a new set of rules which is not necessarily suited for this new and present market.

First we should acknowledge the distinction between two types of independent contractors, high income and low income. High income workers can be engaged as an independent contractors as long as both parties agree. These workers are more than capable to make these decisions themselves and no longer need government-afforded protections. However, in order to classify a worker who makes less than the median annual average wage as an independent contractor, there will be a simple two stage tests:

  1. The first step will be based on the test of economic dependence. The employer may not:
    1. Retain the independent contractors for more than 50 hours per month; or,
    2. Represent more than 30 percent of the independent contractor’s income.
  2. In the second step, the control test will be evaluated, so that the employer may not violate more than four of the following conditions:
    1. May not have the independent contractor work from the company’s office;
    2. May not set the exact working hours;
    3. May not pay the independent contractor monthly or hourly, but rather per completion of a specific project;
    4. May not provide training to the independent contractor;
    5. May not reimburse the independent contractor’s expenses;
    6. May not provide any tools or equipment to the independent contractor;
    7. May not restrict the independent contractor’s ability to negotiate fees.

The greatest strength of this proposal is that it does not introduce any new legislative content, but rather, recommends a reorganization of existing legal structure.

Simply re-organizing employee status

De facto, this is an easy-to-follow interpretation of the tests used today to determine the status of independent workers: control and economic dependence. Therefore, it should not require a traditional legislative and political process, which is long and bureaucratic.

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By reorganizing employee status evaluation rather than re-inventing it, we believe the proposed rubric might expedite the legislative process.

The second most important advantage to the solution we are proposing is the clarity and flexibility it provides. This proposal will help State regulators and the U.S. Department of Labor put forward a clear, quantitative rubric by drawing a very clear distinction between full-time employees and independent contractors. In addition, the unique two steps and threshold structure of our proposal will provide the employers with the flexibility they need for their businesses to better fit the modern and innovative market.

By creating a clear set of rules for lower-skilled independent contractors, we can all ensure workers are protected, companies have the clarity and flexibility they need to operate and the government can continue to generate revenue.

The rise of the on-demand economy carries enormous financial and social potential. What we will do with this enormous potential is up to us.