Public Comments | Gig economy

EPI comments on DOL’s proposed rulemaking on employee or independent contractor classification under the Fair Labor Standards Act

Submitted via regulations.gov 

Amy DeBisschop
Division of Regulations, Legislation, and Interpretation
Wage and Hour Division
U.S. Department of Labor
Room S-3502
200 Constitution Avenue NW
Washington, DC 20210

Re: Employee or Independent Contractor Classification Under the Fair Labor Standards Act (RIN 1235-AA43)

Dear Ms. DeBisschop:

The Economic Policy Institute (EPI) is a nonprofit, nonpartisan think tank created in 1986 to include the needs of low- and middle-income workers in economic policy discussions. EPI conducts research and analysis on the economic status of working America, proposes public policies that protect and improve the economic conditions of low- and middle-income workers, and assesses policies with respect to how well they further those goals. EPI submits these comments on the Department of Labor’s (Department/DOL) Notice of Proposed Rulemaking (NPRM) to revise its analysis for determining who is a covered employee and who is an independent contractor under the Fair Labor Standards Act (FLSA).1

Under the Trump administration, the Department of Labor finalized a rule that narrowed the scope of who is considered an employee under the FLSA. As a result, the Trump rule made it easier for employers to misclassify their workers as independent contractors rather than as employees. The way in which a worker is classified has serious implications and costs for their labor rights and their economic security. When an employer misclassifies a worker as an independent contractor, the employer robs that worker of basic protections such as minimum wage, overtime pay, the right to be free from discrimination in the workplace, access to workers’ compensation, and access to unemployment benefits. While misclassification can happen to any worker, due to occupational segregation and other labor market disparities rooted in structural racism, people of color and immigrant workers are more likely to be in occupations where misclassification is common. We applaud the DOL for proposing to rescind the anti-worker rule and replacing it with a rule that would help protect workers.

In the proposed rule, the Department seeks to reinstate the clear, long-standing six-factor “economic reality” test, which gets to the central issue of worker classification: is the worker truly in business for themselves, or do they depend economically on finding work in the business of others, under the control and terms of the employer? The DOL’s explanation of how each factor should be analyzed also provides clarity and focus, which will help workers and employers alike know who is covered by the Fair Labor Standards Act. The proposed rule also makes clear that the vast majority of workers are not truly in business for themselves independently and should be classified as employees, making them entitled to the FLSA’s rights and protections.

In this comment, we will demonstrate the importance of the proposed rule by estimating the financial benefit to workers who have been incorrectly classified as independent contractors as a result of the lack of clarity caused by the Trump administration’s 2021 rule. The basic structure of this analysis is to estimate (1) the difference in the value of a job to a worker if the worker is classified as an independent contractor rather than as an employee and (2) the difference in payments to social insurance funds if a worker is classified as an independent contractor rather than as an employee.

No comprehensive private or government data exist on the prevalence of the misclassification of workers as independent contractors, overall or by industry or occupation. To illustrate the substantial costs to workers caused by the lack of clarity in the Trump administration rule and the resulting misclassification, we provide estimates here for workers in 11 occupations that researchers have identified as particularly vulnerable to misclassification: construction workers, truck drivers, janitors and cleaners, home health and personal care aides, retail sales workers, housekeeping cleaners, landscaping workers, call center workers, security guards, light truck delivery drivers, and manicurists and pedicurists.2

We illustrate the methodology we used to estimate the cost to workers of being misclassified as an independent contractor using the case of construction workers, an occupation where misclassification is a long-standing, widespread practice and has been studied extensively.

We begin with a breakdown of total compensation for construction workers when they are classified as employees, drawn from the Bureau of Labor Statistics’ Employer Costs for Employee Compensation (ECEC) database. Table 1 presents the most recent ECEC data (June 2022) for construction workers. Their average hourly wage earnings are $33.97 per hour (row one), which is made up of straight pay ($30.39 in wages and salaries, in row two), supplemental pay ($1.61, mostly overtime, in row three), and paid leave ($1.97 in vacation, holiday, sick, and personal day pay). Over and above their pay, construction workers classified as employees also receive significant employee benefits—an average of $5.55 per hour (row five) in insurance (primarily health insurance) and defined benefit or defined contribution retirement benefits. Finally, when workers are as classified as employees, employers are also legally obligated to contribute on the employee’s behalf to Social Security, Medicare, federal and state unemployment insurance, and Workers’ Compensation, which in the case of construction totaled an average of $4.03 per hour (row six). After the various benefits and contributions to social insurance are included, the value of a job to the average construction worker increased from $30.39 per hour in wages and salaries alone to $43.56 per hour in total compensation (row seven).

Table 1

Average compensation profile for construction workers, 2022

 

Compensation component Cost per hour worked  Ratio of compensation to pay
Pay (wages, salaries, supplemental pay, vacation, holiday, sick, personal) $33.97 100.0%
Wages and salaries $30.39 89.5%
Supplemental pay (e.g., overtime) $1.61 4.7%
Paid leave (vacation, holiday, sick, personal) $1.97 5.8%
Insurance benefits and retirement benefits $5.55 16.3%
Legally required benefits (Social Security, Medicare, federal and state unemployment insurance, and Workers’ Compensation) $4.03 11.9%
Total compensation $43.56 128.2%

Note: Totals may not sum exactly due to rounding.

Source: Bureau of Labor Statistics, Employer Costs for Employee Compensation, "Table 4. Employer Costs for Employee Compensation for private industry workers by occupational and industry group," June 2022. https://www.bls.gov/news.release/ecec.t04.htm#ect_table4 Accessed October 24, 2022. Row for: Industry and occupational groups, Goods-producing industries, Construction industry. 

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The ECEC data we use in Table 1 make it possible to breakdown total compensation for workers in construction (and in many other occupations) into its component parts, but only when those workers are classified as employees. No comparable data exist for workers when they are misclassified as independent contractors. Table 2 describes how we adapt the available compensation information for employees in order to provide plausible, conservative estimates of total compensation for workers who are misclassified as independent contractors.

Table 2

Job value to a worker and to social insurance funds, by employment status: Construction workers, 2021 dollars

 

No compensation for health and retirement With full compensation for health and retirement
Cost to worker of independent contractor status Cost to worker of independent contractor status
Payroll employee Independent contractor Dollars Percent Independent contractor Dollars Percent
Value to worker of job that pays
$48,210
A Regular pay $43,129 $43,129 $51,006
B Supplemental pay $2,285 $0 $0
C Paid leave $2,796 $0 $0
D Insurance and retirement benefits $7,877 $0 $0
E [Minus] Paperwork costs independent contractor $1,016 $1,158
F [Minus] Worker contribution to Social Security, Medicare $3,688 $6,443 $7,627
G=A+B+C +D-E-F Net value to worker of job $52,398 $35,670 $16,729 31.9% $42,221 $10,177 19.4%
Value to social insurance funds
F Worker contribution to Social Security and Medicare $3,688 $6,443 $7,627
H Employer contribution to Social Security and Medicare $3,688 $0 $0
I Employer contribution to Unemployment Insurance and Workers’ Compensation $2,031 $0 $0
F+H+I Total payments to social insurance funds $9,407 $6,443 $2,964 31.5% $7,627 $1,781 18.9%

Source: Median annual earnings of 47-0000 Construction and Extraction Occupations from Bureau of Labor Statistics, Occupational Employment and Wage Statistics, May 2021. https://www.bls.gov/oes/current/oes470000.htm, accessed October 24, 2022.

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In Table 2, we apply the breakdown of total compensation from the ECEC data in Table 1 to the annual earnings of the median construction worker, which we obtain from the BLS’s Occupational Employment and Wage Statistics data (OEWS). According to the OEWS data, in 2021 the median construction worker working as an employee (not as an independent contractor) had $48,210 in W-2 earnings. Applying the distribution of compensation from Table 1 to this annual earnings figure, we estimate that the median construction worked received $43,129 per year in regular pay (line A), $2,285 in supplemental pay (line B), and $2,796 in paid leave (line C), and $7,877 in insurance and retirement benefits (line D). The same worker would have had to pay 7.65% of their earnings, or $3,688, toward Social Security and Medicare (line F).3 The net value to the worker of a job under these circumstances–that is, the sum of all pay, paid leave, insurance and benefits, minus Social Security and Medicare taxes–would be $52,398 (line G), substantially higher than the W-2 earnings of $48,210.

We then model two possible ways that workers’ total compensation can change if the employee is misclassified as an independent contractor. In the first case, we assume that construction workers classified as independent contractors lose their supplemental pay (employers are not legally required to pay time-and-a-half overtime to independent contractors, for example), their paid leave (if they aren’t working, they aren’t being paid), and their health insurance and retirement benefits (a major cost-savings for employers who switch employees to independent contractor status). These assumptions substantially reduce the value of the job as an independent contractor relative to the value of the same job when performed as an employee. But these adjustments are incomplete because they don’t account for the additional costs incurred by construction workers hired as independent contractors. The largest cost is the responsibility that independent contractors have to pay both the employee and the employer contributions to Social Security and Medicare. Independent contractors also assume new paperwork costs, including invoicing, bookkeeping, and small business tax filings.4

The second column of numbers in the top panel of Table 2 presents the results of these calculations for the typical construction worker. Here we assume that the annual pay for the independent contractor is identical to the regular pay of the same worker as an employee ($43,129). The independent contractor no longer receives supplemental pay ($0), paid leave ($0), or insurance and retirement benefits ($0), but must now pay the full employer and employee contribution to Social Security and Medicare (15.3%, or $6,443, up from the $3,688 employee contribution as an employee, line F) and cover $1,016 in paperwork costs (line E). Under these assumptions, the net value to the worker of the same job done as an independent contractor falls to $35,670 per year (line G)—a decline of $16,729 or almost one-third of the original net value of the job when done as an employee.

Table 2 also presents a second possible way that employers might treat independent contractors. In the last three columns of the table, we assume that employers pay independent contractors their regular pay and fully compensate them for the cost of health insurance and retirement benefits that employers would have paid to the same worker working as an employee. Given that avoiding the costs of employee benefits is a key motivation for hiring independent contractors rather than employees, we believe it is unlikely that employers would compensate workers in any substantial way for lost employee benefits. But this second case illustrates that even on these more generous terms, the value of the job to independent contractors still drops significantly relative to the value of the same job performed as an employee.

When we calculate the regular pay of the independent contractor as the regular pay as an employee ($43,129, as before) plus the full value of insurance and retirement benefits ($7,877), the annual earnings as an independent contract rises to $51,006–higher than the regular pay of an employee and even higher than total W-2 earnings as an employee ($48,210). But once we factor in Social Security and Medicare contributions ($7,627) and paperwork costs ($1,158), the net value of the job as an independent contractor is only $42,221, still more than $10,000 below the net value of the same job done as an employee. 5 6

The second panel of Table 2 uses the same two sets of assumptions to show the impact on payments to social insurance funds (Social Security, Medicare, federal and state Unemployment Insurance, and Workers Compensation) of the switch from employee status to independent contractor status.

As mentioned above, when workers are employees, they pay the employee share of Social Security and Medicare (7.65% of W-2 earnings). Their employers also make identical payments to Social Security and Medicare. Employers also make contributions on behalf of their employees–but not independent contractors—to federal and state Unemployment Insurance programs and to Workers’ Compensation.7 We estimate that when a worker is classified as an employee, the worker pays $3,688 toward Social Security and Medicare and their employer makes an identical $3,688 contribution toward Social Security and Medicare, and the employer makes additional contributions to Unemployment Insurance and Workers’ Compensation totaling $2,031.

When the same worker is misclassified as an independent contractor, contributions to social insurance fall but the entire burden of social insurance payments is shifted to the worker. Under our first set of assumptions (independent contractors are paid only their regular pay on a job when they are classified as independent contractors), total contributions to social insurance fall 31.5% ($2,964), but the payments made by the worker rise from $3,688 to $6,443. Under our second set of assumptions (independent contractors receive the regular pay on the job plus the full cost of insurance and retirement benefits), payments to social insurance drop 18.9% ($1,781), but again, the direct payments made by the worker increase from $3,688 to $7,627. As an independent contractor, all of the contributions toward fall directly on the worker.

One possible objection to the way that we have estimated the change in the net value of a job to an employee whose job is reclassified as an independent contractor is the claim, made by the Trump administration’s Department of Labor, that “in a competitive labor market, any reduction in benefits and increase in taxes is likely to be offset by higher base earnings—referred to as an ‘earnings premium,’” which would mean that “in theory, companies would likely have to pay more per hour to independent contractors than to employees because independent contractors generally do not receive employer-provided benefits and have higher tax liabilities,” and “any tax-related transfers from employers to workers are likely to be offset by higher wages employers pay to ensure workers’ take-home pay remains the same.”8 However, the Trump Department of Labor went on to note that “this expected wage premium may not always be observable at a statistically significant level” and in fact, their own analysis of the 2017 Contingent Worker Supplement (CWS) data “did not show a statistically significant difference” between the wages of employees and independent contractors with the same demographic characteristics in the same occupation.

This is not surprising given that this optimistic theory of the labor market—that is, that the base pay of former employees will rise to make up for a reduction in benefits associated with independent contractor status—is based on the assumption of perfectly competitive labor markets. There is broad and growing evidence that perfect competition is rare, and that most labor markets do not function competitively—particularly in low-wage labor markets such as many of those under consideration here.9 10 Even workers in the higher paid occupations examined here (particularly construction and trucking) are, in the absence of unionization, likely to lack the power to bargain for higher wages to compensate for their loss of benefits and increase in social insurance taxes when they become independent contractors.

Given these findings, we assume in our first case that low-earnings workers classified as independent contractors receive the same regular pay that they received when they were an employee–that is, there is no wage premium associated with being an independent contractor.11 In our second case, we allow for a large wage premium equal to the dollar value of health insurance and retirement benefits. In both cases, we also further assume that independent contractors receive no supplemental pay (such as overtime, holiday premium pay, shift differentials, or nonproduction bonuses), or paid leave.12

Table 3 presents the results from applying the same methodology applied to construction workers in Tables 1 and 2 and to ten additional occupations that researchers have identified as potentially vulnerable to misclassification.13 The first column of the table shows the median annual earnings in these occupations in 2021. The second column lists the total net value to the worker of the job when that job is classified as an employee. As in Table 1, the total value of the job to an employee includes paid leave (vacation, holidays, and sick pay), supplemental pay (overtime and holiday pay differentials), health insurance coverage, retirement contributions, and employer’s contribution to legally required employee benefits (Social Security, Medicare, federal and state unemployment insurance, and Workers’ Compensation), after subtracting the employee’s own costs to social insurance. The first row reproduces the results for construction workers, which we just reviewed. As we saw earlier, the median construction worker had annual W-2 earnings of $48,210 last year, but the value of the job after including benefits and social insurance contributions was $52,398. The value of that same job when performed as an independent contractor would be substantially lower, ranging from $35,670 to $42,221, depending on the specific assumptions. The estimated cost to the worker of independent contractor status, relative to employee status, is between $10,177 and $16,729 per year.

Table 3

Summary of range of costs to workers of independent contractor status, by representative occupations, 2021 dollars

Range of value to worker of job, as independent contractor Range of cost to worker of independent contractor status
Occupations Median annual W-2 earnings Value to worker, as employee Low estimate High estimate Low estimate of cost to worker High estimate of cost to worker
Construction workers $48,210 $52,398 $35,670 $42,221 $10,177 $16,729
Truck drivers $48,310 $53,003 $34,950 $41,927 $11,076 $18,053
Janitors and cleaners $29,760 $30,140 $22,698 $24,908 $5,232 $7,441
Home health and personal care aides $29,430 $31,194 $21,665 $25,005 $6,189 $9,529
Retail sales workers $29,120 $29,552 $21,854 $24,066 $5,485 $7,697
Housekeeping cleaners $28,780 $29,147 $21,944 $24,081 $5,066 $7,203
Landscaping workers $34,430 $34,869 $26,292 $28,849 $6,021 $8,577
Customer service reps / call center workers $36,920 $36,673 $28,184 $30,328 $6,346 $8,490
Security guards $29,680 $30,846 $22,092 $24,951 $5,896 $8,754
Light truck delivery drivers $29,280 $30,883 $21,803 $24,999 $5,884 $9,081
Manicurists and pedicurists $25,770 $26,099 $19,628 $21,541 $4,558 $6,471

Source: Economic Policy Institute analysis of data from the Bureau of Labor Statistics' National Compensation Survey's Employer Costs for Employee Compensation data and the BLS's Occupational Employment and Wage Statistics data.

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The rest of the table shows the costs to workers in ten other occupations. As employees, these workers have median W-2 earnings between $25,770 and $48,310 per year. Using our most conservative estimate, a switch to independent contractor status reduces the value of their job by between $4,558 (manicurists and pedicurists) to $11,076 (truck drivers). Using equally plausible, but less conservative estimates the range of losses runs from $6,471 to $18,053 per year. Further, very-low-wage employees whose wages are elevated by the minimum wage could easily see their wages drop when, as independent contractors, they no longer legally must be paid the minimum wage.

What might have been left out in this analysis? Firms who hire independent contractors sometimes argue that independent contractor status provides workers with “flexibility and satisfaction,” a potentially important nonpecuniary attribute for workers who would be willing to accept lower income in exchange. Many workers indeed value flexibility, but employers are able to provide substantial flexibility to payroll employees if they choose to do so, while misclassified workers often have very little flexibility. The idea that workers can either have flexibility or payroll employment is a false choice. Moreover, it is difficult to imagine that there are a meaningful number of employees who would receive more satisfaction from doing the identical job for substantially lower compensation as an independent contractor. Finally, workers also highly value other job characteristics, including income stability and scheduling predictability, which are much less prevalent among independent contractors and are not taken into account here.

EPI strongly supports the Department of Labor’s proposed rulemaking regarding employee or independent contractor classification under the Fair Labor Standards Act. The Trump administration’s rule introduced substantial uncertainty into the determination of worker misclassification. As we have demonstrated here that uncertainty exposes workers across a wide range of occupations to potentially large financial hardships. For these reasons, EPI strongly supports the proposed rule and urges the Department to move swiftly to promulgate a final rule.

Sincerely,

Heidi Shierholz
President
Economic Policy Institute
Washington DC

John Schmitt
Senior Economist and Senior Adviser
Economic Policy Institute
Washington DC

Margaret Poydock
Policy Analyst and Government Affairs Specialist
Economic Policy Institute
Washington DC

1. Employee or Independent Contractor Classification Under the Fair Labor Standards Act, 87 Fed. Reg. 62218-62275 (October 13, 2022).

2. For discussions of occupations where workers are particularly vulnerable to misclassification as independent contractors, see Annette Bernhardt, Sarah Thomason, Chris Campos, Allen Prohofsky, Aparna Ramesh, and Jesse Rothstein, Independent Contracting in California: An Analysis of Trends and Characteristics Using Tax Data, UC Berkeley Labor Center and California Policy Lab, March 2022; Françoise Carré, (In)dependent Contractor Misclassification, Economic Policy Institute, June 2015; National Employment Law Project, Independent Contractor Misclassification Imposes Huge Costs on Workers and Federal and State Treasuries, Policy Brief October 2020; and Lisa Xu and Mark Erlich, Economic Consequences of Misclassification in the State of Washington, Harvard Labor and Worklife Program, December 2019.

3. The “total value” is defined as a relatively near-term concept here, in the sense that paying Social Security taxes would likely increase a worker’s Social Security benefits in retirement, so those taxes are not a long-run negative.

4. Updating the methodology laid out by Shierholz (“EPI comments on independent contractor status under the Fair Labor Standards Act,” October 26, 2020.), we estimate these paperwork costs as the annual purchase of basic bookkeeping software ($72, using Freshbooks, see https://www.freshbooks.com/pricing, accessed October 27, 2022), self-employed tax filing software for federal taxes ($119, using TurboTax, https://turbotax.intuit.com/personal-taxes/online/live/, accessed October 27, 2022) and state taxes ($49, using TurboTax), and 39 hours of administrative time per year at the independent contractors implied hourly rate. As Shierholz notes: the IRS “estimates that business taxpayers spend 13 more hours than nonbusiness taxpayers doing their taxes. If we conservatively assume that independent contractors spend 30 minutes per week on other (nontax) paperwork costs that they wouldn’t have to spend if they were a payroll employee, that, plus the additional 13 hours spent on taxes, is an additional 39 hours of paperwork per year”

5. A 2019 report on worker classification in the construction industry prepared by economists Dale Belman and Aaron Sojourner for the Attorney General of the District of Columbia made somewhat different assumptions about the changes in wages after workers move from employee to independent contractor status but arrive at broadly similar conclusions. For example, they estimate that “if misclassified workers receive only half the value of [paid leave, health insurance, and retirement benefits] to which they ought to be entitled, the cost reduction of doing business illegally jumps…to 48.1 percent.” (p. 5) Dale Belman and Aaron Sojourner, “Illegal Worker Misclassification: Payroll Fraud in the District’s Construction Industry,” Issue Brief and Economic Report, Office of the Attorney General of the District of Columbia, September 2019. See also Russell Ormiston, Dale Belman, and Mark Erlich, “An Empirical Methodology to Estimate the Incidence and Costs of Payroll Fraud in the Construction Industry,” January 2020.

6. Economist Michael Reich of the University of California Berkely finds similar results for Uber and Lyft drivers. He estimates that employee status for Uber and Lyft drivers would increase total driver compensation by about 30 percent. See, Michael Reich,“Pay, Passengers and Profits: Effects of Employee Status for California TNC Drivers,” Institute for Research on Labor and Employment Working Paper 107-20, October 2020.

7. We estimate total contributions to state and federal Unemployment Insurance and Workers’ Compensation by taking the value of “legally required benefits” in Table 1 and reducing that by the statutory payments made to Social Security and Medicare (7.65% of earnings).

8. 85 Fed. Reg. at 60626-60627, 60628

9. See. for example, Alan Manning, Monopsony in Motion: Imperfect Competition in Labor Markets (Princeton, N.J.: Princeton University Press, 2003); Anna Sokolova and Todd Sorensen, Monopsony in Labor Markets: A Meta-Analysis, Washington Center for Equitable Growth, February 2020; Arindrajit Dube, Jeff Jacobs, Suresh Naidu, and Siddharth Suri, “Monopsony in Online Labor Markets,” American Economic Review: Insights 2, no. 1 (March 2020): 33-46, https://www.aeaweb.org/articles?id=10.1257/aeri.20180150.

10. In fact, after review by the Office of Information and Regulatory Affairs (OIRA) at the White House, the following sentence was removed from the Trump Department of Labor’s original economic analysis: “The Department anticipates a positive wage effect due to the expected increase in labor force activity, but did not attempt to quantify estimates of changes in earnings.” That removal following OIRA’s review is no surprise, given that a positive wage effect of the proposed rule can’t be supported by the evidence.

11. We are not aware of any studies that directly examine what happens to earnings after workers who are initially classified as employees are later classified as independent contractors. Two studies, however, document declines in earnings for workers who were initially classified as employees but whose positions were later outsourced. Arindrajit Dube and Ethan Kaplan found that outsourced wages fell 4% to 7% for janitors and from 8% to 24% for security guards, with simultaneous declines in health benefits received (“Does Outsourcing Reduce Wages in the Low-Wage Service Occupations? Evidence from Janitors and GuardsILR Review, vol. 63 no. 2, pp. 287–306). Using German administrative data on workers in food, cleaning, security, and logistics services, Deborah Goldschmidt and Johannes F. Schmieder found wages in outsourced jobs declined by approximately 10–15% relative to similar jobs that were not outsourced. (“The Rise of Domestic Outsourcing and the Evolution of the German Wage Structure,” The Quarterly Journal of Economics, vol. 132, no. 3, pp. 1165–1217).

12. Note that an individual with total household earnings on the low-end of the W-2 earnings reported in Table 3 and a household size of three or more (for example, one individual with two children) would likely be eligible for Medicaid. We do not attempt to quantify this effect, but to the extent that workers who change status as a result of this rule are able to take up Medicaid, the transfer to employers related to health care that would result from this rule would be transfers from the social insurance system to employers, not from the worker to employers.

13. See references cited in endnote 1.


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