Taxes And The Gig Economy

Tax Notes senior reporter Paul Jones talks with Richard C. Auxier, senior policy associate at the Urban-Brookings Tax Policy Center, about tax issues raised by the gig economy and how policymakers are working to address them. 

Note: This episode was recorded before a California court decision mandating Uber

UBER
and Lyft

LYFT
to reclassify drivers in the state as employees. 

This post has been edited for length and clarity.

Paul Jones: Richard, thank you for being here today.

Richard Auxier: Thanks so much for having me, Paul.

Paul Jones: I wanted to talk about the gig economy. This is the economy that allows people to request services via a mobile app. It also allows people also to sign up, get paid, and provide those services, such as delivering food or driving people around. This economy has grown pretty rapidly in the last few years.

However, gig workers are not regular employees. As a result, they aren’t subject to withholding or employment taxes in many places currently.

Can you talk about the tax compliance issues that have arisen as a result of this economy and the fact that these workers are not regular employees, but more like independent contractors?

Richard Auxier: Like a lot of issues around the “new” economy in tax, we have new technologies running into old tax issues. In this case, even just an old tax problem. I think it’d be great if we first defined some terms, which is that you can kind of put workers into two buckets. The first is employees, who work for a company and get [a] W-2. Then there’s self-employed workers.

That latter bucket has a range of people, from a plumber who has his own business to a lawyer who decided she’d rather have passthrough income. But that also includes the home care workers and construction workers who instead of getting a W-2 are getting a 1099-MISC. They’re being labeled as self-employed.

The gig economy has highlighted this issue of the definitions, which has always existed. For some, it’s very clear. I get a W-2 at my job. I’m an employee. It was never under any question. The plumber who started his own business, clearly he’s self-employed. But for a lot of people, this comes down to how the employer is labeling the person more than what they’re doing. We know this has been a long-term problem that a lot of people are misclassified. Their employer treats them as a self-employed person to reduce costs so they don’t have to withhold and pay their share of payroll taxes.

With companies like Uber, Lyft, DoorDash, and Instacart, you have these companies that decide they can create a workforce by making them all self-employed people. These workers are literally their own business when they go to file their taxes. The companies say it’s advantageous to them because if you’re your own business, you set your own hours. You are more likely to go out and take a job and be inspired.

But the very large downside of that is these workers lack the protection of employees. That ranges from things like unemployment insurance to minimum wage and worker compensation. But it also means that there are large tax liabilities that they are now responsible for, because in a sense, they are a business.

Paul Jones: I know that I’ve also heard from California officials that there’s relatively low compliance with income tax payments on the money that gig economy workers receive as well. There seems to be a variety of issues here. I know that some states have been working on improving outreach to these workers and working with these companies as well as considering regulations to address some of these problems.

California obviously has gotten a lot of attention because it took the step of establishing A.B. 5, a somewhat controversial new law. It effectively establishes in statute a three-part test for whether a worker is an independent contractor or an employee of a company. It has the effect of redefining a lot of people, including many people in the gig economy, as employees of these companies.

The intention of the backers of A.B. 5 in part is to ensure that these workers and their employers are paying into the unemployment insurance system and withholding it. 

Do you think that this is a law that is going to benefit California? Do you think it’s going to increase tax revenue to the state? That it’s going to improve and provide support for the unemployment system? Or is it potentially going to result in some unintended consequences?

Richard Auxier: Yes to all of it. A.B. 5 is a really important law, but again, it’s important to note that it’s not revolutionary. This isn’t just a law aimed at Uber, Lyft, and these other newer companies who happen to get a lot of attention since they have a lot of money to spend lobbying against these issues.

While most people are employees, there is a large share of self-employment workers. In recent years, it’s been difficult to get a specific number on this, but we know that the self-employment number has been increasing. But it’s been increasing mostly because of a large group of misclassified workers.

It’s hard to figure this out and pin this data down. One of the reasons is that if you ask people whether they’re self-employed or an employee, a lot of people who get 1099-MISCs and are treated like self-employed people think they’re employees. They show up for a job. They have a relationship. They view themselves as a member of that workforce.

California’s law is just creating a tougher standard for who is an employee and who is allowed to be labeled as self-employed. All states have these laws. The IRS has like a 20-question survey trying to figure this out.

But it’s an example where, because the federal rules aren’t that tight at the moment, states like California can go above and beyond this to create these higher standards. If you look through the summaries of the legislation and you listen to people, this is not just about the Uber driver. It’s about someone who shows up to the construction site every day, but is treated as a self-employed person. These have big ramifications for the individuals.

In addition to doing tax analysis, I also volunteer and help low-income filers do their taxes. It is not uncommon to see people who think they are employees show up to do their taxes and realize that no one has paid their payroll share. Their employer has not withheld their income taxes. As a result, they have these very large income tax liabilities when they file.

From the tax perspective, it’s making sure that people that are actually employees are treated as such. One very big component of that is that when you work for an employer, when you have a W-2, your income tax is withheld throughout the year. That would be a source of revenue for the state.

The employers are also addressing payroll taxes. A big one for these gig workers are the federal ones, but states and localities increasingly also have payroll taxes like unemployment insurance. Increasingly, we see states and localities adding things like paid family leave programs, which also create payroll tax responsibilities.

When you are an employee and the employer has a lot of responsibility in that, and when you increase the share of workers who are employees, you increase the amount of revenue and increase the amount of withholding they’re going to have.

Paul Jones: One of the things that I think is interesting is that we’re dealing with a certain portion of the California workforce. Some of these people may simply be using gig economy work as a supplemental income. You also noted that some people may simply be classified as self-employed, but they really work more of a regular full-time job.

Is this likely to be something that is going to bring in a net gain in revenue to the states? Or are these people who may end up taking from the social programs more than they’re putting in? Is it likely to be a net gain for the state?

Or, when you consider, for example, that some people maybe don’t file for the Earned Income Tax Credit, but by increasing the number of people who are filing income tax returns with the state, such as through gig economy work, that you might see an increased demand for the EITC, that this could result in the state actually paying out more to lower-income people?

Richard Auxier: The honest answer is I don’t know. Even your question kind of illuminates how complex this can get. If you want to view this in a simple way, you could frame this as: What is your average worker who is currently treated as self-employed, but who would become an employee under this law?

If he or she is a high-income worker, then it’s almost all gain for the state because now this worker who might not be filing is now having his income tax withheld and is now paying payroll taxes. However, if it’s a low-income filer, it gets a little more complex because they might be eligible for the state EITC. They are now paying their payroll tax at the federal level, but at the state level, they may become eligible for these tax credits, which don’t actually result in the state getting money.

Again, this is the tax issue that has ramifications for several other policies. For example, one of the biggest challenges with paid family leave legislation is that often the target are workers who are hard to cover with the system because the system relies on courting employees and being an employee. If you’re a self-employed worker, you’re not eligible for most of these paid leave programs.

If you make more people employees, they now become eligible for paid family leave programs. But that said, they’re now also paying payroll taxes. Same thing goes with unemployment insurance. They’re not paying the payroll tax while they simultaneously become eligible for the program.

California’s law isn’t revolutionary, but it’s larger. That’s why it’s noteworthy. We can see the ripple effects of this legislation and how it will touch several fiscal programs.

Paul Jones: A.B. 5 impacts California tax compliance for employers by establishing that workers that they’ve traditionally treated as self-employed or independent contractors are actually employees. Do you think that A.B. 5’s requiring employers to treat their California workers as employees is potentially also going to result in them complying with employment tax obligations at the federal level for those employees?

For example, withholding and paying payroll taxes. If an employer essentially is now treating a worker in California as an employee and complying with payroll taxes and such at the state level, then they may just decide to also do that at the federal level?

Or do you think you’ll have maybe a bifurcated system where under A.B. 5., a worker in California is treated as an employee by a company for state tax purposes and state tax compliance purposes, but that they continue to treat them as a self-employed or independent contractor for federal tax purposes?

Richard Auxier: As someone who does not work at a large company that has to make these decisions in another accounting office, I can’t tell you with 100 percent certainty. But I can’t imagine how it would not be the same for both. Some of this becomes this esoteric question of: Who is an employee? Who is self-employed?

Ultimately it comes down to: Are you getting a W-2? If you’re getting a W-2, you’re having your state and federal taxes withheld. This is incredibly important for the worker.

I work with a lot of people who come in with their taxes in the District of Columbia. A lot of the people who drive for Uber, or are a home care worker who’s been labeled as self-employed by the person, come in. The problem doesn’t have anything to do with their state taxes. It’s that they owe both sides of the payroll tax.

The payroll tax for federal Medicare and Social Security is supposed to be split between the employer and employee. However, if you’re self-employed, you pay all of it. Further, as an employee with a W-2, you’re getting that taken out of every paycheck. If you’re labeled self-employed, the employer isn’t paying that half, you’re now responsible for all of it, which is upwards to 12 percent of your earnings for the year.

Secondly, you haven’t been paying it every stop along the way. It’s sadly common to see someone who comes in and is blown away by a tax bill they didn’t know because they’ve been misclassified and because the employer has not been taking that payroll share out.

But then there are a lot of other taxes that just go unreported at the state level, too. New Jersey, when they pushed through some legislation, said Uber owed them $650 million in unemployment and disability taxes. There’s a lot of taxes that don’t even show up when you’re filing taxes that go missing when a worker is misclassified.

Paul Jones: There’s obviously a lot of complexity there and a lot of potential consequences for changing how these workers are treated. On that note, with companies potentially being required to comply now with withholding and employment taxes, is that going to increase their costs? If so, is that going to result in them charging more for people’s services or paying their workers less?

What are some of the potential implications for the gig economy of states like California with, again, A.B. 5 trying to require better compliance with these employment tax obligations and withholding obligations?

Richard Auxier: There’s a couple of things going on here, and we can get into issues of flexibility, which is what Uber and Lyft talk about the most. I have a hard time believing this isn’t all about costs.

Again, if the person working for you is your employee, you pay half of their payroll tax and you have to withhold it. That’s going to drive up costs. The business is then going to try to find a way to shift those costs. This is where it gets interesting. Like I said, all states have these rules, there’s federal rules, but they’re not very tight. States can go above and beyond it, and you get this patchwork of systems.

Another thing that comes into play here is minimum wage. If you’re an employee, you’re eligible for minimum wage. The current thinking goes that when you pay the payroll tax as an employer, you lower your employee’s wage. It all comes out in the wash. You don’t take at least a full hit because you can put that on them.

But in California, minimum wage is $12 and it’s increasing. It’ll be $15 in 2023. It’s not hard to imagine that there are Uber drivers or Instacart workers out there who are currently making less than minimum wage. It’ll become really difficult for that company to push that cost, that payroll tax share they’re not paying, onto the worker if their wages are also now rising up to that level.

Then, of course, you get into the issue of workers working in multiple jurisdictions, which you see mostly in places like New York, New Jersey, Pennsylvania, and other Northeast cities. There are different laws and different minimum wages, and now there’s going to be a different worker test, possibly. You add a whole other level of complexity for these firms to figure out.

I think there are very good reasons to have these rules. I don’t buy into all the arguments against them. I think it’s absolutely true that it will add costs and complexity to these businesses.

Paul Jones: Notably in California, I know that some companies like Uber have litigation arguing that they have essentially taken some steps to sort of change their relationship with workers. For example, not having as much control over how much a driver gets paid for a given trip. They are arguing that this means that they aren’t really subject to A.B. 5’s provisions. They’re claiming that they don’t qualify under the three-part test.

In addition to that, they are also backing a ballot measure to formally and statutorily exempt themselves from A.B. 5. Do you think that we’re going to see if states pursue efforts to get better compliance from gig companies, with respect to various worker protections and obviously tax compliance, that there will be efforts by them to adjust or tweak their business model or even just create fundamental exemptions for themselves to avoid the added burden and complexity?

Richard Auxier: On the policy side of this, there’s going to be a lot of arguments because these companies already found a niche for themselves and they are currently paying people. We’ve seen this in California, where some companies will no longer hire in California or cap the number of people who they’re employing in California so that they don’t trigger A.B. 5.

This then becomes a really tough decision for policymakers. Because you could be very pro-worker and want to ensure that the employee is getting all of the benefits and protections that he or she deserves, it could come in the short term at a cost of jobs. They would just not hire, especially if it’s a patchwork and not a national solution. If states go first, there’s possibility that again, they will be singled out and that the amount of employment in that state will be reduced for these companies.

On the company side of this, I have more questions than answers. That’s because typically what the company would do is shift costs by lowering wages. I think one of the problems that we consistently see with these “gig economies” is that they’re artificially keeping their costs low. A part of it is because they’re not paying their workers what they should be getting paid. They’re not paying the benefits and taxes that they should be paying. Can that company still be profitable with having to call their employees employees? 

A lot of these companies are not profitable already. To add that burden would kind of shake things up. I think the actions that Uber and Lyft have taken in California to get a ballot measure, to carve out an exemption for them, is telling to how distressing this is.

Again, while I acknowledge the costs are very real, I question if there are not other problems with these companies. It’s something to go beyond not wanting to pay their share of payroll taxes.

Paul Jones: Looking at the reaction to A.B. 5 and taking into account the issues that you’ve raised and discussed, do you think that other states are maybe going to try and follow California’s lead? Or are they likely to try and look to maybe come up with their own policies that would differ from California’s?

Is A.B. 5 a policy that you think is going to have other states lining up to adopt it? Or do you think that there’s going to be an effort by other legislators in different states to maybe come up with different ways to address this issue?

Richard Auxier: Yes to all three. For example, New Jersey has passed legislation this year kind of increasing examinations into companies who might be misclassifying workers and increasing penalties on companies that might be misclassifying workers. New York has talked about similar things. I am sure that labor advocates across the country are looking for opportunities to pass A.B. 5-style legislation.

Again, just know this goes beyond just Uber and Lyft. Virginia passed some legislation this year also increasing financial penalties on companies that have misclassified. It didn’t get much attention because they were just kind of joining most other states. They had had some relatively low barriers to this.

Every state has these laws. It’s just a range and where the state is varies depending on their politics and their approach to labor and business, but probably all on very similar lines. If you want to know what states are going to be looking to make these stronger, look at the states that are passing paid leave laws or are trying to eliminate tip minimum wage.

If you want to look at states that are not going to do this, check out right-to-work states. They are probably not going to be looking to change how they treat worker classification.

Uber and Lyft are interesting. Again, because it’s new, there are people working for them that states don’t want to see become unemployed, especially right now. They also have a lot of money and they can lobby for rules. I think that a New York Times article said that half the states have passed laws explicitly deeming drivers as contractors. That is totally lawful. Even the California legislation had language that said, “We are going to make our rules stricter, but that certain people like podiatrists and veterinarians and psychologists are exempt.” They just did not exempt Uber and Lyft. That was the difference.

I think you’re going to see a lot of fights over that carveout in states where states press forward. Misclassification is an issue that goes well beyond the economy. It has ramifications well beyond the tax withholding, but then every time they go have these conversations, Uber and Lyft and similar gig economies are going to be right there, demanding their carveout.

Paul Jones: Uber’s CEO sent a letter to the Trump administration earlier this year during the COVID-19 pandemic’s initial wave and the shutdowns that were occurring. A lot of gig workers were seeing significantly less work. There was a debate about unemployment benefits for gig economy workers and so on.

The Uber CEO’s idea that he proposed to the Trump administration was that there might be a third category created for gig economy workers that were not quite the same as a true self-employed business owner or worker, but also not fully an employee of another company. Do you think there’s any merit to that idea that that’s possibly going to be a part of this conversation going forward?

The idea that this is sort of a new class of worker, maybe too casual to be a true self-employed person as we’ve traditionally understood that, but not quite as at the beck and call a regular worker for a company to be a true employee?

Richard Auxier: This issue is undoubtedly complex, as we’ve proven over the course of our conversation. What I would be interested in, and I’m sure what policymakers are interested in, is where Uber is drawing the line.

For example, we’ve talked about schedules. If you read an article about this and you read a press release, Uber will say these laws are bad because they can’t let people work when they want to work. They’re all about independence. That’s because if you’re an employee, there are worker protections that basically say you can’t be forced to work all the time.

I am quite sure that state and federal lawmakers would be interested to work an arrangement out where someone who drives for Uber or works in a similar gig employment is allowed more flexibility in their schedule because they’ve chosen that type of work. We do some of this already.

For example, in most states, if you work as a bartender or a server, you can be paid a smaller minimum wage than the regular minimum wage. We do have carveouts. But an important footnote on that is that servers are supposed to report their tips to their employer so that the employer can pay payroll taxes on their income.

Does Uber’s proposal include them paying their share of federal payroll taxes? Does it include them paying state and local payroll taxes? Does it include them withholding income taxes?

I am a little cynical about that because I think that’s what they’re really concerned about. I don’t think it’s about flexibility. I think it is about these tax issues we’ve been discussing and that they don’t want to pay them. It just depends on what they want.

I do think that there are ways to assist these workers and companies around certain issues. But if the issue is that simply we don’t want to pay these costs that other employers do, then I don’t think you’re going to get a very receptive audience from a lot of lawmakers.

Paul Jones: It sounds like, in a way, what we’re dealing with is a new spin on an older question, as you alluded to earlier. Richard, thank you so much for speaking with us about this topic. I really appreciate it.

Richard Auxier: Thank you so much, Paul. It’s been a pleasure.