Everything You Need to Know About the Department of Labor Independent Contractor Rule

The intention, the potential benefits and costs, and more...

Today the Department of Labor’s (DOL) independent contractor rule goes into effect. It adds new considerations that significantly limit the circumstances under which a worker can legally be classified as an independent contractor—a stricter rule than it was under the Obama administration. Practically what this means is that it will be more difficult to engage in freelancing, gig work, or types of independent work—across all professions and occupations, no exemptions.

What does the rule do?

The rule narrows the definition of “independent contractor.” It does this by first retracting a Trump-era 2021 rule that was more favorable to the independent contractor status and second by providing additional considerations to the six-factor economic realities test that significantly limit the circumstances under which a worker can legally be classified as an independent contractor. This piece by Littler provides a thorough analysis of how each factor changes under the new rule.

The intention:

Combat problems of misclassification and try to make more independent contractors become employees, who would have access to proper benefits and protections. The idea is to make it more difficult to hire independent contractors so that organizations will hire workers as employees instead.

Targeted Group:

All independent contractors, across all professions and industries, no exemptions. Some quick facts on independent contractors below, which I covered in detail in my Labor Myth Busting Series: The Gig Economy:

• About 10 to 29 percent of U.S. workers engage in independent work as their primary source of income, and up to 39 percent use it as a supplementary source of income

• Gig workers are only a small subset of all independent contractors.

• The majority of gig workers already have a full-time or part-time W-2 job and are supplemental earners on app-based platforms. This is also true of the broader independent contractor workforce, most of whom are supplemental earners.

• Independent contractors and gig workers significantly value the flexibility that comes with their non-traditional work arrangements and most would not prefer to be W-2 employees.

• The independent workforce is growing, especially in professional, scientific, and technical services and healthcare

The Potential Benefits:

The primary benefit of this rule, and as stated by the DOL, is that workers would obtain employee benefits and protections because they’ll now be subject to all the employment-based regulations (minimum wage and overtime, family and medical leave, health insurance, etc.). The DOL attempts to estimate the value and quantify these additional benefits and protections for workers. The DOL also discusses these benefits in terms of reduced misclassification.

In other words, the independent contractors who now become employees because of the new regulation will gain the most.

The natural question is: how many of these independent contractors will actually become employees?

The DOL does not provide an analysis of how many independent contractors will actually become employees. Let’s say a company is contracting with 100 photographers, all of whom are affected by this rule: how many of those photographers will become employees? It’s clearly not all 100 of them. To unpack the potential benefits (and costs) on workers, we need some analysis into how many of those 100 freelance photographers would become employees.

Another consideration for the benefits side of the equation is whether most independent contractors are currently working with small businesses or larger ones. This matters because, as I point out in a previous post, many small businesses do not provide healthcare insurance, retirement benefits, or maternity benefits to their employees. This means that the “benefits” differences between an independent contractor and an employee at a small business are smaller than expected. It’s worth noting that the growth of independent contractors has been the fastest for small and low-wage businesses (fewer than 20 employees), followed by medium firms (20-100) and lastly by large firms (more than 100), according to IRS tax records.

The Potential Costs:

The most important consideration for the cost side is how many workers would now be turned away from their contracting jobs (because it’s now illegal under the new regulation) without a W-2 employment offer in hand. Let’s go back to the company that contracts with 100 photographers and our question from above: how many of these independent contractors will actually become employees?

If only 1 freelance photographer becomes an employee and the company cuts off working with all other 99 photographers, that’s a significant cost. If instead 99 freelance photographers become employees and only 1 is cut-off, the costs are small.

Let’s turn to the DOL assessment—what does the DOL say about the potential job losses and costs for our photographer scenario: “The Department does not believe the rule will lead to job losses.”

In other words, the DOL believes that all 100 freelance photographers affected by the rule will be hired as employees instead.

Of course, it’s also possible that the rule does not change anything about the relationship between the company and the photographers, so therefore, in this specific scenario, there will be zero benefits (no one is reclassified as an employee) and zero costs (all freelance photographers keep their contracts with the company).

Since the DOL does not provide an assessment of how many independent contractors affected by the rule will actually become employees, we turn to empirical studies on this.

In our new study, my co-authors and I provide the first and only empirical investigation of reclassification policies in the United States by analyzing the effects of California Assembly Bill 5 (AB5), the country’s strictest law for working as an independent contractor.

There is a debate about the effects of AB5. Lawmakers like to argue that AB5 induced some employers to reclassify independent contractors as employees to comply with the law, and thereby increased the share of workers who received employment-based benefits and protections. Others argue that while some independent contractors may have been reclassified as employees, many more likely lost their jobs because employers cannot reclassify all or most independent contractors as employees.

Contrary to the goals of the lawmakers, we find no consistent evidence that traditional (W-2) employment increased for non-exempt occupations in California post-AB5.

We find that AB5 is associated with a significant decline in self-employment and overall employment for non-exempt occupations in California. Specifically:

• Self-employment fell by 10.5 percent on average for non-exempt occupations, while overall employment fell by 4.4 percent on average for non-exempt occupations

• Occupations with a greater prevalence of self-employed workers saw greater reductions in both self-employment and overall employment

IN SHORT: On average, 1 in 10 self-employed individuals may have lost self-employment opportunities in California among occupations not exempt from AB5, while there is no evidence of an accompanying increase in traditional employment opportunities among workers in non-exempt occupations. 

Our study seems consistent with the anecdotal evidence.  News articles described job losses for the creative community of freelancers, such as professional choral artists, classical performers and singers, dancers, actors and musicians. Several other reports showed job losses for translators and interpreters, court transcript editors, writers and truck drivers. Due to this backlash, California later exempted these professions, and many others, from AB5.

What our findings imply for the 100 photographers scenario under the DOL rule is that most photographers are unlikely to become employees and that a some photographers could lose their contracting opportunities.

These potential job losses could be quite large, especially for contractors who work with small businesses and non-profit organizations. That’s because even in cases where workers are properly classified as independent contractors, the rule will deter organizations that cannot afford extensive legal counsel from working with contractors altogether, as was the case in California with AB5.

The Unintended Consequences:

I discussed these consequences in a policy brief, and below I provide a quick summary:

1. Substantial Job Losses for Independent Workers. Many independent workers would not receive the additional benefits associated with becoming employees, because many of them would neither become employees nor be able to maintain their jobs as independent workers. This is because companies will not extend all contracting positions into employment positions, thereby leaving workers with fewer job opportunities altogether. 

2. Fewer Options for Individuals Facing Income Loss. Independent work is an important source of income for those who face income loss and unemployment. Therefore, the loss of independent work opportunities would cause particular harm to these more vulnerable individuals.

3. Fewer Options for Majority of Workers Who Prefer Independent Work. According to the Bureau of Labor Statistics, a majority of independent workers (79 percent) prefer their nontraditional job arrangements over a traditional employment arrangement. Independent work provides far more flexibility in terms of work schedule, which gives workers more freedom to choose what time and how often to work. By contrast, traditional employment often means a specified schedule (e.g., nine-to-five) and a specified quantity of work (e.g., 48 weeks a year).

4. Disadvantage Women’s Employment Opportunities. Restricting independent work opportunities and reclassifying independent work as traditional employment would disadvantage women, many of whom tend to be the primary caregivers in their families and turn to independent work for the flexibility they need in their work schedules. Survey research reveals that 96 percent of women preferred to participate in independent work precisely because they need the flexibility in working hours.

5. Hamper Workers Who Had Contact with the Criminal Justice System. Restricting independent work would disproportionately harm the criminal justice population, because recent evidence shows that the gig economy provides an important avenue to work for those who previously had a criminal record.

6. Unduly Constraint Small, Innovation-Driven Technology Startups. Restricting independent work would harm small technology startups that rely on independent workers. In a survey of technology startup CEOs, 57 percent indicated that the use of contract labor is an indispensable or essential part of their business model, and 39 percent indicated that its highly valuable to their business models. Executives said that they required contract labor because they needed individuals with specialized talent or for one-off projects (69 percent) or because they needed flexibility, given the risk associated with early stage development (60 percent).

The Legal Concerns:

The Administrative Procedure Act (APA) requires all federal agencies to provide a reasoned determination of the costs and benefits for new rules. Agencies are also required to thoroughly assess alternative solutions and choose the rule that minimizes costs on society.

The DOL failed to consider the most significant cost in question—the potential job losses — even after many brought this to their attention. I addressed it in a public interest comment, op-ed, and in a meeting with the Office of Information and Regulatory Affairs (OIRA), where 6 members of the DOL were present.

There are at least four groups suing the Department of Labor on these grounds and other arguments (e.g. the new rule is too vague and open-ended).

• Freelance writers sue the DOL (represented by Pacific Legal Foundation)

• Freelance journalists (represented by Beacon Center)

• Coalition for Workforce Innovation & U.S. Chamber lawsuit (with many other groups)

• A trucking business (represented by Liberty Justice Center or Pelican Institute)

It’s possible that a judge will suspend the rule.

Conclusion:

1. The DOL rule will make it more difficult to engage in freelancing, gig work, or types of independent work across the nation.

2. The rule retracts a 2021 Trump-era rule *AND* adds new considerations that more strictly define “independent contractor.” This is a stricter standard than it was under the Obama administration.

3. It targets all independent contractors across all industries and professions. It’s worth noting that most independent contractors are supplementary earners and that only a minority of independent contractors are part of the “gig economy.”

4. The primary benefit of this rule is that workers would obtain employee benefits and protections, but it’s not clear how many independent contractors who are affected by this rule will actually become employees.

5. The most significant cost in question is how many independent contractors will lose their contracting opportunities without being offered a W-2 job. The DOL fails to do a proper analysis on this and assumes (without any evidence) that there will be zero job losses and costs, but research shows otherwise.

6. There are many other unintended consequences not addressed by the DOL including the potential impact on women and those who had contact with the criminal justice system

7. Because the DOL failed to address costs and other considerations in the rule, there are pending lawsuits which might mean the rule is suspended

Are there better ways to address this workforce? Check out “Let's Address the Real Challenges for Independent Contractors and Gig Workers”