New Worker Classification Rule Could Disrupt the U.S. Gig Economy

App-based ride-sharing services such as Uber (UBER) and Lyft (LYFT) earned the title of “disruptors” for the way they drove traditional cab companies out of business. Now, they’re trying to fend off the disruption that could be coming for them, in the form of a new federal labor rule.

A new regulation on worker classification released this month is already facing at least one legal challenge, and will likely see more pushback from gig economy companies whose business model it threatens. The new law could turn the gig economy upside down, and affect many of the estimated 22.1 million Americans who work as independent contractors, employment experts say.

Earlier this month, the Department of Labor released details on a rule setting standards on when a worker counts as an employee as opposed to an independent contractor, entitling them to overtime pay, unemployment insurance, and a slew of other benefits under the law. The new rule, first proposed in 2022, is set to go into effect in March. 

This week, a group of freelancers, including three New Jersey-based writers, sued the Department of Labor to overturn the new rule. At least one major business lobbying group is also considering legal action.

Should the government give “employee” status to workers currently classified as contractors, it would threaten the business models of companies such as Uber, Lyft, and Doordash (DASH), whose contract workers cost their employers much less than traditional employees would.

Uber and the Flex Association—a trade group representing gig economy companies—both released statements last week saying that the rule would have no immediate impact on their businesses.

“This rule does not materially change the law under which we operate, and will not impact the classification of the over one million Americans who turn to Uber to earn money flexibly,” Uber’s statement reads.

Millions Could Be Reclassified Under New Rules

Erin Hatton, a sociology professor at the University at Buffalo who has studied the gig economy, predicted that when the new rule goes into effect, Uber and Lyft drivers, and millions of other gig workers, could in fact be reclassified as employees.

“Their employment model will not survive a shift to construing their employees as legally covered employees,” Hatton said. “They have deep pockets and they will push back with all their might against this.”

The U.S. Chamber of Commerce, a business lobbying group, said it was considering suing to stop the rule.

“The Department of Labor’s new regulation redefining when someone is an employee or an independent contractor is clearly biased towards declaring most independent contractors as employees, a move that will decrease flexibility and opportunity and result in lost earning opportunities for millions of Americans,”  Marc Freedman, vice president of workplace policy at the chamber, said in a statement. “It threatens the flexibility of individuals to work when and how they want and could have significant negative impacts on our economy.”

When is a Worker an Employee?

The rule concerns a distinction that’s become increasingly important amid the rise of gig-based companies that provide rides, dog-walking, food delivery, and a slew of other services: When is a worker an employee, and when are they just a contractor?

The difference matters because labor laws at the federal, state, and local levels give employers a host of obligations to their employees. Nationwide, those considered “employees” are entitled to minimum wage, overtime pay, the right to form unions, and other protections of the Fair Labor Standards Act. Employers also have to contribute to Social Security and Medicare when they cut paychecks for employees.

At the state level, employees get unemployment insurance and can claim workman’s compensation insurance if they’re injured on the job. In some states, they’re also entitled to paid family leave and sick days.

None of that applies to independent contractors, who, in the eyes of employment law, are more like little companies, each establishing a business relationship on equal footing with the employer. 

Rather than being subject to regulations, the terms of employment are set by a mutually agreed-upon contract—even if it is usually written by the big company and is a “take-it-or-leave-it” prospect for the contractor, said Samantha Prince, a law professor at Penn State Dickinson Law, and an expert on worker classification and the gig economy.

The new regulation, similar to an older Obama-era rule, says there are six factors to evaluate whether someone is an independent contractor or an employee: “opportunity for profit or loss depending on managerial skill, investments by the worker and the potential employer, the degree of permanence of the work relationship, the nature and degree of control, the extent to which the work performed is an integral part of the potential employer’s business, and skill and initiative.”

Contractors Miss Out on Pay and Benefits

In reality, how those standards apply to any given worker will be determined by judges evaluating those factors in court cases, Prince said. For instance, many Uber drivers seem to meet four of the six criteria for being considered an employee, she said.

“And is that going to be enough for a court to say that for purposes of the FLSA Uber drivers are employees?,” she said. “It’s possible.”

Because of how much cheaper and simpler it is to hire a contractor versus an employee, businesses have incentives to classify people as contractors as a cost-cutting measure, even when it’s not appropriate.

For example, misclassification is rampant in the construction industry, according to an analysis by the Century Foundation, a progressive think tank, which found that 10-19% of the entire workforce—as many as 2.1 million people—were misclassified or paid under the table.

Because of the lack of benefits and overtime pay, independent contractors are often compensated less for doing the same jobs. A typical person working in construction as an independent contractor would make as much as $16,729 less per year in income and benefits compared to what they would as an employee, the Economic Policy Institute, a progressive think tank, estimated.

Despite the drawbacks, many contractors say they would prefer not to be considered employees and have pushed back against worker classification rules. 

“This lawsuit seeks to vindicate the right of individual entrepreneurs to remain independent in the face of a concerted effort to force them into employment relationships they neither want nor need,” the freelancer lawsuit reads.

Flexibility or Benefits? Employees Can Have Both

A 2023 survey by job hunting site Indeed found that people working as independent contractors value independence and flexibility of hours that come with those roles, preferring those perks to higher salaries.

However, Prince and Hatton said there’s no legal reason that employers couldn’t offer flexible work arrangements alongside the benefits that come with employee status.

“There’s no law that says that you can’t be an employee and have flexible hours,” Prince said.

“It’s a completely false dichotomy between this flexibility—sometimes true and not always so true—and permanent employment or legally classified employment,” Hatton said. “Those simply don’t have to be mutually exclusive.”