All Commentary
Friday, August 14, 2015

What’s at Stake in the War on Contractors

Making people "employees" against their will limits their options and crushes innovation

The haters of the sharing economy are rallying around a plan for destroying the most spectacular ad innovative sector of modern economic life. It’s taken them a few years, during which the digital revolution seemed unstoppable.

The hint came from a speech by Hillary Clinton at the New School in which she suggested that current “contractors” be redefined as “employees.” According to her, this means that the workers can then enjoy new human rights, as if by magic. Hillary’s comments amount to a cloud no bigger than a man’s hand. She was speaking for the entire cabal of special interests who dream of crushing innovation.

Hillary poses as a spokesperson for the worker. What it actually means for employment is that many will be out of a job.

A good case in point is what happened to Zirtual, a fabulous California that enabled personal-assistant contracting. You need someone to deal with email, social, and scheduling, and you connect with those who can provide such services. The company had 500 contractors, even aside from those who had signed up, and revenue was booming.

Faced with some fear and ambiguity about the legal status of contractors in California, the management of Zirtual made them all employees and put them on the payroll. The burn rate (the pace at which expenses outrun revenue) went on overdrive. The result was frightening. The company went belly up virtually overnight, firing everyone out of financial necessity.

And it’s not just about the workers. Customers too are harmed by being denied access to new and cheaper services.

Who benefits by forcing contractors to become employees? Old-economy labor and capital structures — complete with high entry costs, centralized corporatization, political connections, union privileges, government regulations, tax withholding, and all the rest.

This seemingly small change, the haters believe, can give the advantage to government-approved incumbent enterprises over startup competitors. They might be right in the short term.

Small Change, Big Effects

The significance of the difference in these legal designations is easily lost on people who are not in business. It comes down to this: for every contractor who is redefined as an employee, you have to add an additional 20-30% in costs borne by the company. At the very least. It’s not just about providing new benefits. It’s also about the massive costs of processing and dealing with administration.

This is poison for startups. It means massive cuts in the number of workers you can pay. It could mean bankruptcy. It would certain mean a serious blow to the sharing economy that has given the world services such as Lyft, Uber, AirBnB, TaskRabbit, and a thousand other new and exciting services. Essentially it means blowing up a market-based business model and replacing it with what is increasingly becoming an anachronism.

The big economic shift of the last decade has come from technology that has newly empowered people to connect with other people directly via mobile applications. Many people’s livelihoods now depend on this technology.

So far we have taken the terms of employment for granted. They have exploited a loophole in the tax system, one designed for independent contractors that have miraculously escaped getting sucked into the W2 borg created during and after World War II.

Under a contractor arrangement, the workers are really the capitalists. They own their own tools, set their own hours, take their own risks. The company they are contracting with merely facilitates an exchange between seller and buyer. As one Uber driver told me, “I’m a venture capitalist.”

But if the government forces an end to the contractor designation, and the tens of millions of people who use it, employers will have to take on massive new burdens. They will have to take out withholding tax, provide health insurance, tax people in new ways, offer unemployment insurance, and provide a huge panoply of mandated benefits. This is what it means to be an employee in the United States today.

To be a contract employee means that you work your own hours, you manage your own taxes, are responsible for your own health care, but you also own your own tools and equipment and face no restrictions on the terms of your business association. You manage your own life.

The contractor designation gets us much closer to how things would be in a free market. Before the government started mucking with employment contracts, labor and capital made agreements in the same way as producers and consumers. They negotiated the terms. They traded to their mutual benefit. All parties won.

The Wrecking of the Employment Contract

The interventions began more than 100 years ago with the income tax that slowly began to pillage salaries. Then came “child” labor laws, minimum wages, Social Security, and unemployment insurance. Then came actual control of wages in the New Deal.

It really got bad in World War II with the withholding tax that turned businesses into tax-collection agencies. The pace of decline accelerated after the war. More goodies were added in the “payroll tax,” which surreptitiously collects more from the average household than the income tax.

The result is strange. All these taxes and mandates were supposed to create worker rights. What they actually do is fundamentally change the nature of the employment contract. It replaces mutual benefit with a dependency relationship that has seriously bogged down labor markets.

How many people do you know who hold on to jobs they hate just because they like the “benefits” that come with them? I know plenty. It’s called job lock, and it’s ruining work, calcifying the economy, and limiting choices for many people.

All these interventions have made labor markets less dynamic, reduce human choice, harmed new business creation, and roped vast swaths of the enterprising sector into a tight relationship with government. The end result doesn’t look like free enterprise. It looks like corporate fascism.

The sharing economy is providing new options by exploiting the hint of freedom that still exists. And thanks to mobile technology and the app economy, the results have been spectacular. Innovation, job creation, consumer services, unimagined forms of progress — all trace to this one feature of the labor contract.

This is why the plot to change the designation is so insidious. You don’t have to do anything but tighten the way the IRS regards these contracts. That can be done through an administrative ruling. No legislation is even necessary. One memo, a few court cases, and you are done. The most brilliant single change in economic structures in our time is blown to smithereens.

In truth, the technology to link labor and capital on a peer-to-peer basis isn’t going anywhere. It is already loose in the world. The US political system can either embrace it as progress or strangle it in the crib and, with it, kill growth prospects for the future.