Report Finds California’s Misclassification Law Hurt Employment

Employment fell for nonexempt occupations in California following the enactment of the state’s strict worker misclassification law, according to a new report.

California’s AB 5 took effect in January 2020. It codified a 2018 California Supreme Court decision that imposed a three-pronged test to determine a worker’s legal classification status and rendered most workers employees unless it could be proven that they are independent contractors. Eventually, over 100 occupations were exempted from the law, and California voters passed a ballot measure in late 2020 that additionally exempted drivers for app-based ride-hailing and delivery services.

Researchers from the Mercatus Center at George Mason University in Arlington, Va., examined how AB 5 affected the labor market by comparing the employment outcomes of occupations that were affected by the law in California to those same occupations in other states before and after AB 5 went into effect.

The study concluded that self-employment in California fell by 10.5 percent on average for nonexempt occupations, while overall employment in the state fell by 4.4 percent on average for nonexempt occupations. Occupations with a greater prevalence of self-employed workers saw greater reductions in both self-employment and overall employment, as businesses were perhaps less willing to work with independent contractors or freelancers for fear of running afoul of the law.

“Contrary to the goals of the lawmakers, we find no consistent evidence that traditional W-2 employment increased for nonexempt occupations in California post-AB 5,” said co-author Liya Palagashvili, senior research fellow at the Mercatus Center. “On average, 1 in 10 self-employed individuals may have lost self-employment opportunities in California among occupations not exempt from AB 5.”

The report’s authors suggest the loss in employment could be because some contractors declined offers of full employment and businesses did not hire independent contractors because of a fear of liability. It’s also possible some businesses that rely on independent contractors were forced to shut down completely, the authors said.

“The findings are unsurprising,” said James Fessenden, a partner in the San Diego office of Fisher Phillips. “Making it harder, more expensive, and more administratively burdensome to work is not a formula for increasing the number of workers. There are surely some good intentions from the California law, but it targets and penalizes working adults from engaging in business transactions that are mutually beneficial.”

At the National Level

The new research raises concerns about the U.S. Department of Labor’s (DOL’s) new rule, issued in January, that would make it more difficult for workers to be legally classified as independent contractors. It takes effect March 11.

“There’s a real danger in extending the consequences of worker reclassification laws nationwide,” Palagashvili said. “Again, the intention here is to alter the composition of the workforce—more workers would become employees, and fewer workers would be independent contractors. Unintended as they may be, the consequences of the DOL rule would likely be similar to those of California’s AB 5.”

However, Fessenden said the DOL rule is “unlikely to reach anything as draconian as the California law.”

“I suspect there will be increased scrutiny of independent contractor relationships that are clear misclassifications, particularly where there is no potential for profit,” he said. “But those kinds of relationships are the minority.”

The DOL said “there may be conceptual overlap” between the factors in its six-factor test and the prongs of the California test, but that the two tests are different.

Ensuring Benefits for All

One of the driving reasons to reclassify independent contractors as employees is because contractors are not entitled to minimum wage, overtime pay and other benefits under the federal Fair Labor Standards Act. Independent contractors have the potential to earn higher compensation compared to full-time employees, but they are also responsible for their own expenses, including taxes and insurance. Contractors may also experience fluctuations in income and may not have the same job stability as full-time employees.

Palagashvili suggested another way to address this challenge without eliminating the flexibility of independent and gig work is to provide portable benefits that are not tied to a particular employer. “State and federal policies could decouple benefits from traditional employment and allow access to benefits for all workers,” she said.