The Labor Department’s independent contractor rule is good — Congress can make it better

Last month the Department of Labor (DOL) proposed a new rule concerning independent contractor status under the Fair Labor Standards Act (FLSA). The clarity it provides would partially solve something that has long troubled employers: that their independent contractors could unexpectedly be turned into highly regulated (and therefore, higher-cost) employees by a court decision.

The proposal is a good start, but Congress could do even more to help entrepreneurs create jobs. Given the depth of the pandemic recession, the more barriers to employment we can remove, the better.

The proposal builds on various “economic reality” tests currently employed by courts. The DOL suggests that two primary factors – an individual’s control over their work and their opportunity for profit or loss based on their initiative – should have greater weight in determining whether they are classified as an independent contractor. Other factors, like the amount of skill required for the work, the degree of permanency of the economic relationship, and the extent to which the worker’s services are an integral part of the business, would be secondary. 

This approach has several benefits. First, because previous case-by-case judicial interpretations had created overlapping definitions, and there was no agreed-upon hierarchy of importance, it should reduce confusion in a growing labor market sector.

Second, it creates an even-handed framework for assessing whether a person is working as an employee or an independent contractor. This is a welcome departure from California’s recent judicial and legislative reforms in the Dynamex state supreme court decision and Assembly Bill 5 (AB 5), which presume that a worker is an employee unless a strict set of conditions are met. We’ve written extensively on the harms to job growth and economic development that California’s new direction has created.

However, even though the proposed rule is a step in the right direction, it still leaves a less-than-ideal situation. The secondary factors – skills, permanency and how integral the service is – don’t really determine whether someone is in business for themselves. It would be better to rely on the primary factors alone. Furthermore, the proposed rule is still subjective, meaning the DOL and courts will still have to interpret whether a bargain struck between a worker and employer meets the right criteria. In other words, it increases clarity, but does not guarantee certainty. 

Unfortunately, because the DOL is constrained by existing precedent and the FLSA, it may not be able to enact further reforms. Congress, however, could fundamentally rethink the federal approach to worker classification law.

So, what could Congress do differently? Well, a couple of things. 

First, it could instruct the DOL and the courts to look to an underlying contract as the sole determinant of a worker’s classification. This would provide workers and employers with virtual certainty as to how these relationships will be classified. It would also allow employers to offer independent contractors employment benefits without fear of having their business models upended by a court decision. 

More holistically, Congress could reassess whether worker classifications still make sense in the first place. A worker classified as an employee results in higher regulatory costs and reduced business flexibility. As we detail in a soon-to-be released public interest comment, such regulations can lower workers’ take-home pay, decrease employers’ demand for workers, increase prices and lower quality for consumers, and inhibit the innovation that drives economic development. 

For example, one estimate has California’s AB 5 costing Uber and Lyft an additional $3,625 per driver each year. And because most economic research finds that workers primarily bear the cost of labor regulations, it will be workers who suffer through reduced compensation. If the platform firms fail to overturn the law, expect substantial job losses as they adjust to a new business model. Fewer workers will work more hours, and those still employed will likely see lower hourly wages.

There should be no question that doing away with worker classifications would necessitate a significant paradigm change. Many safety-net programs are implemented via government mandates on businesses to provide benefits to employees. That makes this type of labor reform complicated, but still worthwhile. Using labor policy as a welfare tool can sometimes be akin to taking two steps forward, one step backward and then spinning around until you’re dizzy. 

The current safety-net programs would be best replaced with individual-focused, market-oriented, social programs. Moving from regulatory to fiscal programs would improve efficacy and transparency, while the reduced costs of labor regulations would help unleash greater economic development.

The labor market has changed drastically since the foundation for our current labor policy was put in place. Congress could help entrepreneurs create new jobs and advance economic development, while improving the social safety net, by starting fresh. It’s rare to have a win-win in politics, but the opportunity is there.

Michael Farren is a research fellow and Trace Mitchell is a research associate with the Mercatus Center at George Mason University.