California’s Assembly Bill 5 Shows How Good Intentions Can Lead to Bad Consequences

In a recent op-ed with the Orange County Register, we discussed how California’s new worker classification law – Assembly Bill 5 (AB-5) – will likely end up harming the very people it was ostensibly intended to help: gig economy workers. However, these workers are not the only group who will have to bear the brunt of this new legislation—smaller entrepreneurs will struggle more with the burdens it imposes and, as a result, the law will help enshrine incumbents like Uber and TaskRabbit at the top of the gig economy. 

The new law codifies a three-part test for determining whether a worker is legally classified as an employee or an independent contractor. Under this rule, a worker can only be classified as an independent contractor if they are: 

1.    Not under the direct control of the hiring firm when performing their work
2.    Performing work that is not within the hiring firm’s general course of business
3.    Working in an “independent established trade, occupation or business” that does the same thing they would be doing. 

Both the structure of this bill and the rhetoric used to justify it make it clear that this new policy is aimed specifically at firms engaged in the gig economy. In a Sacramento Bee op-ed expressing support for the bill, Governor Gavin Newsom (D) explicitly said that the “federal government will be no help here” because the “Trump administration has declared that workers in the gig economy are independent contractors.” 

The pointed nature of this legislation is made even more obvious by the numerous professions expressly exempted from this policy. AB-5 does not apply to:

• physicians
• lawyers
• dentists             
• securities brokers
• psychologists
• investment advisors
• veterinarians
• private investigators
• architects
•  direct salespersons
•  engineers
• licensed insurance agents
• accountants
• commercial fisherman

as well as a variety of other people “performing work under a contract for professional services.” 

It almost seems that gig-economy workers are the only ones without a special exemption from this law.

But while the law was clearly created to change the employment policies of large companies like Uber, Lyft, and DoorDash, they are not the ones it will hurt the most. Large gig economy firms may be unhappy with this new rule—Uber and Lyft have already said they do not plan to alter their worker classifications and will fight any reclassifications in court—but they also have the capabilities, resources, and scale necessary to re-engineer their operations to in order to comply with it. Smaller companies and startups often have less capacity to comply with such mandates, especially those that create fixed costs that must be spread over a smaller number of workers or business transactions.. 

For example, Uber and Lyft are enormous companies, together controlling over 95 percent of the $50 billion ride-sharing market within the United States. While they may be able to adjust their operations to incorporate the higher cost of providing health insurance, overtime pay, and other employee-specific benefits (like unemployment insurance) to drivers who would now be classified as employees, their smaller current and would-be future competitors would likely have a harder time getting over this hurdle. 

The relatively higher burden on smaller companies may cause decreased competition within the gig economy, leading to an increase in the market power of big firms. This means, ironically, that Uber and Lyft may end up being among the largest beneficiaries of this new rule. The higher prices they’d have to charge to accommodate the increased employment costs would reduce passengers’ demand for their services, but the regulatory complexity would also inhibit would-be competitors, helping to enshrine their position as top dog.

And it’s not just the well-being of their current competitors that we should be worried about. Mandated business practices (like detailing which employment benefits must be offered to workers) inhibit new business creation by restricting innovation and raising costs.  This is not to say that innovation within the gig economy will grind to a halt as a result of AB-5, but the more expensive you make something, the less of it you are likely to see. 

In fact, because the gig economy has been so revolutionary in supplying highly-desired services to customers over the last decade, restricting its capacity to innovate may lead to a substantially worse future than we’d otherwise enjoy.

The long-run effect of AB-5 and similar regulations will likely make it harder for smaller firms and future startups to challenge these predominant players, and that means there will be less motivation to develop the new and better services that would attract (and benefit) customers in the future. In fact, it would be better if California went in the opposite direction and considered getting rid of employment classifications altogether. A more open regulatory environment may help quell the state’s out-migration of businesses and encourage the next tech industry unicorn to choose California as its home.