New Study on California AB5 and Implications for the Department of Labor’s Independent Contractor Rule

Self-employment and overall employment significantly decreased in California post-AB5, and we find no robust evidence that traditional (W-2) employment increased post AB5

Freelancing, platform-mediated “gig” work, and other forms of self-employment are at an all-time high in the United States and the rest of the world. Over a third of America’s workforce engaged in some type of independent work in 2023.

As this type of work continues to play a larger and unprecedented role in the economy, efforts have sprung up in recent years to regulate independent contracting. These efforts primarily aim to address ‘misclassification’ and to move more independent contractors to traditional employment so they can receive various employment-based benefits and protections. For example, last week a Department of Labor rule created a stricter rule nationwide that would make it more difficult to work as an independent contractor. Several states are also experimenting with various regulations and worker reclassification rules. 

Despite the growth of worker reclassification policies, there are no empirical studies that investigate the impact of those policies.

In our new study, we provide the first 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 this rule. Proponents of AB5 argued that it 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. They argue that even in cases where workers were properly classified as independent contractors, AB5 still deterred organizations, especially small businesses that could not afford extensive legal counsel, from working with contractors altogether.

Our question: What happened in California post-AB5?

Our analysis compares the employment outcomes of occupations that were not exempt from AB5 within California to those same occupations outside of California before and after AB5 was enacted.

The key findings:

• Self-employment and overall employment for non-exempt occupations significantly decreased post-AB5

  • 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 employment (e.g. farmers and ranchers, chiropractors, repairers)

  • For example, self-employment fell by almost one-third (28 percent) and overall employment fell by as much as 14 percent  for occupations that had a high prevalence of self-employment

• We find no robust evidence that traditional (W-2) employment increased post AB5

  • Our findings imply that AB5 did not necessarily lead to more W-2 employment as intended by lawmakers

  • Even in cases where we see an increase in W-2 employment, this increase was not large enough to offset the significant decreases in self-employment, thereby resulting in an overall reduction of employment in California

• Overall, the findings in our study suggest that AB5 did not simply alter the composition of the workforce as intended, with more workers becoming employees and fewer workers as independent contractors. Instead, AB5 is associated with a significant drop in self-employment and overall employment for non-exempt occupations in California.

While we could not test this in our study given data limitations, there are several ways AB5 could have led to a decrease in overall employment:

1.     First, employers may have hired some, but not most, independent contractors as employees, while other employers may have stopped working with their contractors based in California altogether.

2.     Second, some employers may have extended employment opportunities to independent contractors who then declined such offers. Workers with a strong preference for flexible hours or for working with multiple clients, for instance, may not have wanted to work as traditional employees with one company.

3.     Third, some small business owners may have been forced to shut down if they relied heavily on independent contractors and could not afford to hire them as employees or stopped working with independent contractors because of fear of compliance. This was highlighted by interviews of small business owners in the wake of AB5.

Implications for the Department of Labor’s Independent Contracting Rule

On January 7, 2024, the Department of Labor (DOL) issued a new rule that more narrowly defines what it means to be an independent contractor under the Fair Labor Standards Act. That rule 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 both the Obama and Trump administrations (here is my policy brief on the rule and its implications). The goal of the DOL rule is to merely alter the composition of the workforce—more workers would become employees and fewer workers would be independent contractors.

The results of our study on reclassification policies can shed light on the potential consequences of the new DOL independent contractor rule.

Our results suggest that the DOL rule may lead to a significant decrease in self-employment and overall employment nationwide. We expect that the occupations with a greater prevalence of self-employed workers will see the largest declines in self-employment and overall employment.

Further, it is not clear whether the new DOL rule would definitively lead to an increase in traditional employment, as intended. Even if the DOL rule could lead to an increase in traditional employment in some industries, our results suggest that the increase in traditional employment will likely not be greater than the reduction in self-employment, thereby leading to a decrease in overall employment nationwide.

Therefore, our study suggests that the DOL will face significant limitations in meeting their intended results and that the rule may have additional negative consequences that were not accounted for in the DOL regulatory impact analysis.

While the DOL rule is not as stringent as AB5, their rule cannot exempt any industries, occupations, or professions like AB5 did, and thus the effect of the rule is expected to be more widespread than AB5 was in California.

Better Policies to Meet the Needs of Independent Workers

Far from delivering intended gains, reclassification efforts like California’s AB5 and the Department of Labor’s new rule on independent contractors may harm this growing segment of the US labor force. Indeed, these changes might leave many workers with fewer job opportunities altogether, as illustrated by anecdotal evidence and our new study on AB5 in California.

Flexible forms of work are beneficial and are desirable opportunities for a large set of working Americans (especially for women). Indeed, 79 percent of independent contractors said they preferred their work arrangements and would not like to have an employment arrangement. We should embrace and welcome the reality that many Americans choose and prefer these types of nontraditional work arrangements.

At the same time, we can work to fix the shortcomings that exist in these flexible work arrangements—for example, workers do not have access to benefits afforded to traditional employees. These limitations have led to policy battles across states and on the federal level. These tensions are arising because our system prioritizes the immobility of benefits (e.g., healthcare being tied to one employer) in a world where worker preferences have shifted and more value is placed on choice and portability. Indeed, a survey found that 80 percent of self-employed respondents would like access to flexible or portable benefits—benefits that are not tied to a particular job or employer.

Instead of restricting independent work, policymakers should provide independent contractors with more desirable options through flexible benefits that will allow them to maintain their nontraditional arrangements while accessing work-related benefits.

A system of flexible benefits for a flexible workforce is the best sustainable solution in the long run if the nature of work continues to change and as flexible and diverse forms of work become the new norm. Embracing innovative reforms such as flexible benefits —benefits that are not tied to a particular employer—will help both workers and employers seize more opportunities in this evolving economy.