Staffing to Address New Independent Contractor Test

The 2020‑21 Governor’s budget includes two labor proposals related to Chapter 296 of 2019 (AB 5, Gonzalez), a new law that limits what types of work businesses can hire independent contractors to do. In this post, we provide a background on the new law, discuss how many workers it might affect, and make recommendations about the workload proposals at the Department of Industrial Relations (DIR) and the Employment Development Department (EDD).

Background

Employment Laws, Benefits, and Protections. State law requires that employers follow rules about employee wages, hours, and breaks. These rules set the state minimum hourly wage and when rest and meal breaks must be provided. Employers also must provide certain benefits, including having insurance to cover on-the-job injuries, reimbursing employees for job expenses, and contributing to unemployment insurance. Finally, employees have certain job protections—for example, taking time off due to illness, a short-term disability, or to bond with a new child. On top of wages, benefits and protections typically add about 30 percent to a worker’s total compensation.

Employment Laws, Benefits, and Protections Apply to Employees, Not Contractors. Employers must comply with laws, benefits, and job protections for their employees. They are not required to do so for those who do work for a company but are not employees—known as independent contractors. However, independent contractors may only perform certain types of work. State rules set the type of work independent contractors can do.

New State Law Limits Who Companies Can Hire as Independent Contractors. The state recently enacted AB 5, which limits what types of work businesses can hire independent contractors to do. Specifically, the new law adopts the "ABC" test from a recent court ruling, which requires an employer to show that its contractors: (A) work independently, (B) do work that is different than what the business does, and (C) also work for other businesses or the public. If an employer cannot show that a contractor’s work meets all three parts of the test, the employer must reclassify the contractor as an employee. Due to the new test, which more strictly limits independent contractor work, many people who previously worked as independent contractors will be reclassified as employees. However, the law does not require businesses to hire independent contractors who are reclassified as employees. For businesses that choose to hire reclassified independent contractors as employees, state employment laws, benefits, and job protections apply.

New Law Also Exempts Some Professions From the ABC Test. The new law exempts some professions from the new test. These workers may continue working as independent contractors. Workers excluded from the new test include, among others, physicians, construction contractors, real estate agents, attorneys, accountants, private detectives, and travel agents.

How Many Independent Contractors Does AB 5 Affect?

The new worker status law applies to most independent contractors in the state. For many of these workers, the business they work for will no longer be able to treat them as independent contractors. Whether businesses hire these workers as employees, however, depends on how companies, contractors, and consumers respond to the new test. Below, we describe what we know, and do not know, about how many contractors the law applies to and how many of these reclassified workers will be hired as employees:

How Many Independent Contractors Does the New ABC Test Apply To? We estimate that roughly 1 million workers will need to meet the ABC test to continue working as independent contractors. This estimate includes workers who report being self-employed in their main job and who work in professions that are not exempt under AB 5. It also includes workers who earn self-employment income on the side. It does not include (1) self-employed managers, who may be small business owners; (2) self-employed truckers, journalists, or drivers, whose status is being decided in the courts; or (3) self-employed workers in professions exempt from the ABC test under AB 5. This is our best effort at determining the number of independent contractors AB 5 applies to, not how many will be reclassified and hired as employees. We address that question below.
How Many Independent Contractors Will Be Hired as Employees Due to AB 5? At this early stage, we cannot predict the exact number of contractors who will become employees due to AB 5. Although we cannot predict the exact figure, it is probably much smaller than the roughly 1 million contractors that AB 5 applies to for three reasons. First, some workers we include in our estimate are probably small business owners, such as artists or accountants, not independent contractors. (Federal survey and tax data are not detailed enough to separate the two.) Second, some workers may meet the ABC test and continue working as contractors. Third, businesses will comply with the law in different ways. Some businesses may hire their contractors as employees, while others may hire some, but not all, of their contractors. Other businesses may decide to stop working with their California-based contractors.
Initial Estimates Could Be Possible in the Coming Months. The main reason we cannot estimate the number of contractors who will become employees due to AB 5 is that the law went into effect January 1, 2020 and therefore no employment data is available. As monthly employment data becomes available, our office will be able to better gauge the number of contractors who have become employees under AB 5. We expect to be able to provide additional information by April.

Department of Industrial Relations

The DIR’s mission is to protect California’s workforce, improve working conditions, and enhance opportunities for profitable employment. Within DIR, the Division of Workers’ Compensation (DWC) oversees the state’s workers’ compensation system, the Labor Commissioner’s Office enforces the state’s employment laws, and the Division of Occupational Safety and Health (Cal/OSHA) sets and enforces standards for workplace health and safety.

Proposal

The 2020‑21 Governor’s budget includes 103.5 positions and $17.5 million special funds annually for three years for DIR to address estimated AB 5 workload. The administration expects AB 5 to lead to additional payroll employees. New employees will increase the need for various DIR services, including adjudicating and managing more workers’ compensation claims at DWC (63 positions), investigating violations and conducting outreach at the Labor Commissioner’s Office (26.5), and conducting additional inspections at Cal/OSHA (2). The proposal also requests 12 support staff.

Funding Source. The administration proposes to fund the DIR staffing increase with an increased assessment on employers’ workers’ compensation insurance. The state collects about $1.1 billion from employers through these assessments. In general, the state uses these dollars to fund operations at DWC and Cal/OSHA and a part of operations at the Labor Commissioner’s Office.

Analysis

Predicting AB 5 Workload Difficult at This Early Stage . . . As we noted earlier, at this time we cannot predict how many contractors will be reclassified and hired as employees due to AB 5. Consistent with this, the administration refers to its estimates of the number of new employees as “speculative.”

. . . Nevertheless, Proposal Likely Overstates DWC Staffing Needs. Three-quarters of the requested positions are for the DWC to adjudicate and manage new workers’ compensation claims. The department based the need for these 73 positions on an assumption that workers’ compensation claims would increase by 10 percent due to AB 5. This suggests that 1.8 million independent contractors will be reclassified and hired as payroll employees under AB 5 (1.8 million is 10 percent of current payroll employment in the state, 18 million). The administration did not provide a clear justification for how it arrived at this assumption. Alternatively, we estimate that roughly 1 million contractors will need to meet the ABC test to remain independent contractors, and that fewer than 1 million will be reclassified and hired as employees as a result. Therefore, in our view, the proposal likely overstates staffing needs related to adjudicating and managing workers’ compensation claims.

Recommendation

We recommend the Legislature withhold action on this request until a more informed workload estimate is available. Should the Legislature prefer to not delay action, we recommend approving a DWC staff and funding level that is in line with our lower workload estimate.

Option 1: Withhold Action Until Initial Estimate of AB 5’s Effect Available. The Legislature could delay action on this request until later this spring or during the May Revision budget hearings. Delaying now would allow our office, and potentially the administration, to more accurately assess how AB 5 will affect DIR’s workload based on upcoming employment data.

Option 2: Reduce DWC Staffing Request to Match Lower Workload Estimate. Should the Legislature prefer to not delay action, we propose that it adopt a 6 percent staffing increase (about 40 staff) instead of a 10 percent increase (73 staff) as put forth by the administration. Our proposal would provide DWC the resources to adjudicate workers’ compensation claims in the event that about 1 million independent contractors are reclassified and hired as employees under AB 5. Despite suggesting fewer staff than the administration has put forth, our recommendation nevertheless errs on the side of caution in that it assumes businesses hire every independent contractor as an employee, an improbable outcome for reasons discussed earlier.

Employment Development Department

EDD administers the state’s unemployment, paid family leave, and short-term disability insurance programs; collects state payroll taxes from businesses and employees; and helps administer federal work training programs.

Proposal

The 2020‑21 Governor’s budget includes $3.4 million General Fund and 24 positions for EDD to implement AB 5. The proposal also requests $3.2 million General Fund in 2021‑22 and $2 million General Fund in 2022‑23. The department has requested resources for AB 5 because its auditors, when reviewing business payroll taxes, must determine if a worker is an independent contractor or employee. According to the administration, key activities include training auditors to apply the new test, preparing audit findings for related appeals, updating forms, explaining changes, and reviewing employer data in the department’s compliance database.

Analysis

Although Key Details Are Not Public, Proposal Appears Reasonable. The administration’s budget proposal lacks key details for the Legislature to review in assessing the request. For example, the proposal does not include the number of positions to be hired or how, specifically, the funds would be spent. Based on supplementary information we requested from the administration, we know that the proposal includes funding for 20 tax auditor positions, most of whom would work additional payroll tax appeals related to AB 5. Other tax auditors would host outreach seminars about the new ABC test for employers. Based on our review of the requested information, the administration’s proposal appears reasonable. However, without a public proposal that includes this information, it is not possible for the Legislature and the public to assess the administration’s proposal or to evaluate, in future years, how implementation has progressed.

Recommendation

Withhold Action and Request Further Information. We recommend that the Legislature withhold action on this item until the department has provided additional details about the proposal, such as:

What would the department accomplish with the requested resources?
How frequently do employers appeal tax audit findings? Due to AB 5, how many additional appeals does the administration expect and how was this figure determined?
How did the department determine how many auditors it would require for new appeals?
The EDD expects to apply the new ABC test when conducting employer payroll audits. Other state agencies also may apply the ABC test—for instance, for wage and hour requirements or workers’ compensation coverage. What will happen if different state entities, in applying the ABC test, reach different conclusions?
Does EDD anticipate that the audit-related workload will be ongoing?