The “Independent Worker” Proposal:
A Step Sideways Rather than Forward

The gig/sharing/on-demand economy is a hot topic among the media, consumers, workers, and policymakers. The benefits of the sharing economy to consumers are well-established, but the relationship between platform firms, such as Uber, and their workers is more controversial.

Currently, there is a lot of uncertainty around the relationship between platform firms and their workers, as some regulators are calling them employees while others are confirming Uber’s claim that they are independent contractors. This uncertainty, combined with several conflicting court rulings, led Seth Harris of Cornell University and Alan Krueger of Princeton University to propose a new category of worker — the “Independent Worker” — in a recently released Hamilton Project paper. The purpose of this proposal is to create a new legal category of employment that falls between a full-fledged employee and an independent contractor. These two categories have been the only worker classifications in the US since their inception by the National Labor Relations Act of 1935. As the sharing economy grows the ambiguity in worker classification will likely cause continued problems for platform firms and workers alike, so we commend the authors for proposing a solution, thereby taking the first step in starting a constructive conversation on the topic. That being said, we think the authors’ proposal maintains the more problematic elements of the current employer-employee relationship that instead should be the focus of reform.

While Harris and Krueger’s investigation does provide some data and economic analysis, it primarily provides a normative recommendation that seeks to uphold what they call the “social compact” between employer and employee. On page 6 of their paper they state:

“The social compact has served the United States well and, in our view, should be preserved and protected unless there are compelling reasons to alter it.”

The social compact they are referring to is the legal arrangement between employers and employees that involves not only monetary payments for services rendered, but other non-wage benefits such as health insurance, payments to Social Security, workers’ disability compensation, unemployment insurance, overtime pay, Affordable Care Act (ACA) eligibility, and an assured minimum wage. Their proposal involves requiring employers to provide some of these benefits — the ones that are currently associated with the status of simply being employed (rather than those which are dependent on the number of hours worked) — to workers who meet their “independent worker” classification. These benefits are primarily health insurance and Social Security payments, as well as tax withholding by the employer. As it currently stands, independent contractors are responsible for determining their own tax liability and contributing to required social programs, like Social Security.

Discussion of the “Independent Worker” Proposal

Workers in the sharing economy often have other full or part-time jobs, many of which provide health insurance. Harris and Krueger argue that platform firms such as Uber are free-riding off of these other employers since Uber is not legally obligated to contribute to their drivers’ health care. Moreover, because independent contractors do not count against the 50 employee rule of the ACA, Uber does not have to pay a penalty if it doesn’t contribute to drivers’ health insurance. To remedy this the authors propose that platform firms be required to pay 5% of independent workers’ earnings (net of commissions) to support health insurance tax subsidies in the ACA exchanges. (It’s not clear how the authors determined that 5% was the correct value, as there is no explanation in the text and no footnote.)

Harris and Krueger’s use of the term “free-riding” implies that platform firms are exploiting a market failure by not contributing to a worker’s healthcare. Their assertion presumes a social norm that a worker is entitled to healthcare provided by an employer, rather than it being considered as part of the worker’s overall compensation.

In reality, the “free-riding” they identify is not a market failure but is instead a policy-induced externality (PIE). PIEs are outcomes experienced by third-parties, which are sometimes but not always harmful, resulting from government regulations and mandates that tilt the economic playing field and alter people’s incentives. Similar to other economic externalities, PIEs are distortionary and result in economic inefficiency. Another example of a PIE would be a firm limiting an employee’s hours to less than the 30-hour full-time threshold to avoid being required to comply with ACA requirements. In this case, the worker is harmed by an artificial limitation in work hours and income caused by the firm’s response to government policy.

As a matter of fact, the reason that health insurance is primarily provided by employers rather than bought individually like car or life insurance is attributable to government policies from the 1940s and 50s. As explained in this NBER paper:

“First, during World War II the War Labor Board ruled that wage and price controls did not apply to fringe benefits such as health insurance, leading many employers to institute ESI (employment sponsored insurance). Second, in the late 1940s the National Labor Relations Board ruled that health insurance and other employee benefit plans were subject to collective bargaining. Third, in 1954 the Internal Revenue Service decreed that health insurance premiums paid by employers were exempt from income taxation.”

The latter IRS decree made health insurance relatively more attractive than wages as a form of compensation, leading employers at the time to often offer it in place of wage increases. Without these government policies employer-provided insurance would likely be less prevalent, or at least not as widely expected by employees, and often replaced by higher wages. In short, the changes in government rules 70 years ago are responsible for the labor market structure, expectations, and institutions we see today. If platform firms are free-riding as Harris and Krueger claim, it is because the government has created rules that encourage it.

A Modest Counter-Proposal: First, Fix the Real Problems

However, we argue against the idea that responding to the incentives created by government policy should be considered “free-riding” — doing so would perversely change the meaning of the term. If a person looks at the world around them and sees apparent free-riding or other market failures, they should first ascertain whether it is an actual failure of the free market or rather a failure of government policy. Harris and Krueger’s argument that a PIE creates an opportunity for free-riding conflates government failure with market failure. Furthermore, suggesting that additional governmental interference is necessary to correct previous policy failures is akin to trying to drink yourself out of a hangover. It’s impossible to use the hair of the dog to twist a previous economic distortion back into some semblance of the free market — all you get is a poorly-stitched Frankenstein’s monster that must constantly be sewn back together, becoming ever more freakish in the process.

During the debates over the ACA both the Left and the Right argued for decoupling health insurance from employers. After the ACA’s passage this discussion has largely fallen by the wayside, but the growth of the sharing economy is presenting yet another reason why this decoupling is important. Instead of forcing all sharing economy workers to participate in the same antiquated and distorted health insurance market as the rest of us, we should use this opportunity to stress the importance of creating a real free market for health care that allows all consumers to buy the policies they want and carry them from job to job. The ACA half-heartedly attempted to address the portability concern but it is failing miserably. Real market reforms are a better solution than simply doubling down on the current broken system.

Harris and Krueger also want platform firms to pay half of independent workers’ Federal Insurance Contributions Act (FICA) payroll taxes for Social Security and Medicare. Their rationale is to make the employer’s contribution to FICA equivalent between independent workers and employees. While this would reduce the incentive for an employer to use one classification of worker over another, it again preserves an unsound policy. Krueger’s own research has shown that most non-wage compensation is borne by the employee in the form of lower wages. Furthermore, forcing sharing economy workers to accept social security payments in lieu of wages is likely to make them worse off since value is subjective, making cash better than in-kind or non-cash benefits.

If it’s truly important to compel people to save for retirement, a better solution would be to simply require that a portion of a worker’s paycheck be deposited in a private retirement account. This would give sharing economy workers the flexibility to choose the investments that make sense for them rather than investing all of their money in the unhealthy Social Security system. The sharing economy provides a great opportunity to implement private retirement accounts that give workers greater control over their future, rather than trusting it to government bureaucrats.

Lastly, we want to be clear that we are not advocating for the brazen removal of social safety nets. Rather, we assert that it is important to realize that implementing such social programs through labor law 1) Severely distorts labor markets, resulting in diminished wages, reduced opportunities for employment, and slower economic growth, and 2) Limits the ability of social safety nets to reach those who need them most.

If social safety nets are to be enacted, they should be done in simple and direct ways to minimize economic distortions. For example, Finland is considering replacing its array of overlapping social programs with a simple national basic income in order to improve efficiency and encourage the unemployed to get back to work. Similar systems have been suggested in the US by Nobel laureate Milton Friedman and noted poverty researcher Robert Lampman. Regardless of the specifics, any social safety net should take special care to avoid causing economic inefficiency, since economic growth is the surest way to fight poverty.

Conclusion

We appreciate Harris and Krueger’s thought-provoking proposal and we agree with them that this is simply the beginning of a long discussion regarding how to achieve the best possible labor market outcomes given the rapidly evolving nature of work. However, their suggestion to create a third worker legal classification misses addressing the real distortions in the labor market caused by policy-induced externalities. It would result in a step sideways, rather than forwards.

Furthermore, the “social compact” that Harris and Krueger want to save was created by labor laws from a bygone era. It is inefficient and outdated. However, the rise of the sharing economy presents an opportunity to implement real changes regarding how people purchase health insurance and save for retirement, which would remove PIE-related distortions and allow for greater economic efficiency to be achieved. This opportunity shouldn’t be squandered by simply perpetuating the imprudent policies of the past.

Adam A. Millsap and Michael Farren are Research Fellows at the Mercatus Center at George Mason University