Skip to page content
Office of the Secretary
Bookmark and Share

V. Contingent Workers

1. General Observations

As employers seek new ways to make the employment relationship more flexible, they have increasingly relied on a variety of arrangements popularly known as "contingent work." The use of independent contractors and part-time, temporary, seasonal, and leased workers has expanded tremendously in recent years. The Commission views this change both as a healthy development and a cause for concern.

On the positive side, contingent employment relationships are in many respects a sensible response to today's competitive global marketplace. The benefits are clear that various forms of contingent work can offer to both some management and some workers. Contingent arrangements allow some firms to maximize workforce flexibility in the face of seasonal and cyclical forces and the demands of modern methods such as just-in-time production. This same flexibility helps some workers, more of whom must balance the demands of family and work as the numbers of d On the negative side, as the Fact Finding Report noted, contingent arrangements may be introduced simply to reduce the amount of compensation paid by the firm for the same amount and value of work, which raises some serious social questions. This is particularly true because contingent workers are drawn disproportionately from the most vulnera- ble sectors of the workforce. They often receive less pay and benefits than traditional full-time or "permanent" workers, and they are less likely to benefit from the protections of labor and employment laws. A large percent- age of workers who hold part-time or temporary positions do so involuntarily. The expansion of contingent work has contributed to the increasing gap between high and low wage workers and to the increasing sense of insecurity among workers noted in the Fact Finding Report, (pp. 93-94).ual-earner and single-parent households rise. Workers benefit when a diversity of employment relationships is available. For example, temporary work provides a mechanism for transitions between jobs, affording employers and workers an opportunity to size each other up before deciding to enter into a more stable employment relationship. Manpower Incorporated CEO Mitchell S. Fromstein told the Commission that his firm transitioned approximately 150,000 "temps" into permanent jobs with client companies in 1993 alone.<Footnote: Statement of July 25, 1994, at 3.>

Unfortunately, current tax, labor and employment law gives employers and employees incentives to create contingent relationships not for the sake of flexibility or efficiency but in order to evade their legal obligations. For example, an employer and a worker may see advantages wholly unrelated to efficiency or flexibility in treating the worker as an independent contractor rather than an employee. The employer will not have to make contributions to Social Security, unemployment insurance, workers' compensation, and health insurance, will save the administrative expense of withholding, and will be relieved of responsibility to the worker under labor and employment laws. The worker will lose the protection of those laws and benefits and the employer's contribution to Social Security, but may accept the arrangement nonetheless because it gives him or her an opportunity for immediate and even illegitimate financial gains through underpayment of taxes. Many low-wage workers have no practical choice in the matter. The federal govern- ment loses billions of dollars to underpayment of taxes by workers misclassified as independent contractors. A 1989 GAO study found that 38 percent of the employers examined misclassified employees as independent contractors. <Footnote: GAO/GGD-89-107 Misclassification of Workers, 2. See Committee on Government Operations, U.S. House of Representatives, "The Administration and Enforcement of Employment Taxes--A Status Report on Ideas for Change," 1994. Also see, Advisory Council on Unemployment Compensation, Misclassification of Workers as Independent Contractors, November 1994.> A June 1994 study conducted by the accounting firm Coopers & Lybrand estimates that revenue loss due to misclassification will total $3.3 billion annually by 1996.<Footnote: "Projection of the Loss in Federal Tax Revenues due to Misclassification of Workers," submitted July 25, 1994 by the Coalition for Fair Worker Classification.>

The Commission does not believe these problems render contingent forms of work inherently illegitimate. On the contrary, we affirm the valuable role contingent arrange- ments can play in diversifying the forms of employment relationship available to meet the needs of American companies and workers. The goal of public policy should be to remove incentives to use them for illegitimate purposes. We believe the changes in labor and employment law discussed below will make a contribution toward achieving this goal.

2. Recommendations

In light of the considerations discussed above, we make recommendations regarding contingent workers in two areas:

  1. The definition of employee in labor, employment, and tax law should be modernized, simplified, and standardized. Instead of the control test borrowed from the old common law of master and servant, the definition should be based on the economic realities underlying the relationship between the worker and the party benefiting from the worker's services.
  2. The definition of employer should also be standardized and grounded in the economic realities of the employment relationship. Congress and the NLRB should remove the incentives that now exist for firms to use variations in corporate form to avoid responsibility for the people who do their work.

The Commission received a number of other proposals about contingent work, many of which merit serious attention. We devoted a hearing to the subject on July 25, 1994. A working group of the Commission held a round table discussion with ten groups representing low wage workers on October 7, 1994. On both occasions, we heard testimony about the plight of people on the lowest rungs of the employment ladder. More workers now find themselves in contingent employment relationships than ever before.

Among the ideas advanced in these forums and in written submissions to the Commission were expanding the coverage of various statutes to seasonal workers; affording farm workers the protections of the NLRA; mandating equal pay for equal work as well as equal benefits on a pro-rata basis for part- time employees; giving employees of contractors a right of first refusal when they are displaced because their employer loses a contract for ongoing services; and putting a time limit on temporary positions, so that they would convert to regular employee positions with the client firm after a specified time period.

The Commission takes no position on these proposals. Frankly, it is beyond our means to recommend a full policy program in this emerging area of concern. However, we wish to emphasize the importance of a comprehensive study <Footnote: The Bureau of Labor Statistics announced on December 9, l994 its first comprehensive survey of the contingent workforce as a supplement to the current population survey, the results to be available in June l995.> to develop a balanced public policy to mediate the concerns of flexibility and productivity on the one hand and economic security and fairness on the other.

1. The Definition of Employee

The single most important factor in determining which workers are covered by employment and labor statutes is the way the line is drawn between employees and independent contractors. Each labor and employment law statute covers only those it defines as employees. The statutes do not protect others, notably independent contractors. When one thinks of an independent contractor relationship, one normally thinks of one firm hiring a second firm--with its own staff, equipment, and resources-- to do certain work, instead of having its own employees do it. The problems arise when the first firm hires not another firm but a single or several individuals to do work, and then wishes to treat those individuals as independent contractors rather than as employees. There are two major problems with the definition of employee in current labor and employment law: (1) each statute makes the distinction in its own way, presenting employers with an unnecessarily complicated regulatory maze; (2) in substance, the law is based on a nineteenth century concept whose purposes are wholly unrelated to contemporary employment policy.

The NLRA, the Civil Rights Act, the Fair Labor Standards Act, the Employee Retirement Income Security Act ~ each major labor and employment statute -- has its own definition of employee and its own way of drawing the line between employees and independent contractors. Many of these definitions appear to be quite similar. But they were created over a period of a half century, and their language is often vague or circular, leaving them open to a broad range of interpretations. As a result, the line has been drawn differently in the different statutes, depending on the inclinations of the agency at the time or Supreme Court doing the drawing. These differences in interpretation mean that a worker might be deemed an employee for purposes of the FLSA but an independent contractor for purposes of the NLRA, without any apparent policy justification for the disparity of treatment. The Commission finds no principled justification for this regulatory morass.

As for the substance of the definition of employee, the legal debate has been framed from the beginning by the common law distinction between an employee and independent contractor. This nineteenth century concept was created by judges for purposes such as determining when a "master" should be held liable for torts committed by a "servant." The doctrine emphasizes the degree of control the master has over the servant, on the theory that a person with little control over the actions of another should not be liable for them. Over the years, the doctrine has grown highly formalistic, to the point that the IRS, which uses a version of it for determining tax liability, employs 20 factors in drawing the employee/independent contractor line.<Footnote: Internal Revenue Manual, 4600 Employment Tax Procedure, Exhibit 4640-1.> Given the proliferation of factors making up the test, its application often yields inconsistent results. What is more, its formalism provides employers and workers with a means and incentive to circumvent the employment policies of the nation. Whatever the actual nature of their relationship, an employer and worker can structure it on paper to give the latter indepen- dent contractor rather than employee status.

While some statutes, notably the FLSA,<Footnote: See U.S. v. Silk, 331 U.S. 704 (1947).> have diverged from the traditional independent contractor test, others, such as the NLRA,<Footnote: NLRB v. United Insurance Company of America, 390 U.S. 256 (1968).> follow it closely. Two years ago, the Supreme Court gave the test new life in the case of Nationwide Mutual Insurance Company v. Darden.<Footnote: 112 S.Ct. 1344 (1992).> The Darden Court concluded that ERISA's definition of employee was meaningless. To solve this problem, the Court held that when Congress fails to define a term that has a settled meaning at common law, courts should infer that Congress meant to adopt the common law definition. Thus, under ERISA an employee means a worker under the direct control of the employer ~ i.e., one who is not a common law independent contractor. Darden has already begun to reverberate in the employment law field well beyond ERISA.<Footnote: Some lower courts have decided they must apply the common law test to Title VII as well as ERISA. See, e.g., Lattanzio v. Security National Bank, 825 F.Supp. 86 (E.D.Pa. 1993) (expressly disregarding the Third Circuit's previous reliance on another test).>

1. Streamline and Modernize the Definition of Employee

The Commission concludes that the ancient doctrine of master and servant provides a poor vehicle for delivering federal employment policy into the twenty-first century. The law in this area should be modernized and streamlined: there is no need for every federal employment and labor statute to have its own definition of employee. We recommend that Congress adopt a single, coherent concept of employee and apply it across the board in employment and labor law.

2. Use an Economic Realities Test to Determine Who is an Employee

The determination of whether a worker is an employee protected by federal labor and employment law should not be based on the degree of immediate control the employer exercises over the worker, but rather on the underlying eco- nomic realities of the relationship. Workers should be treated as independent contractors if they are truly independent entrepreneurs performing services for clients ~ i.e., if they present themselves to the general public as an established business presence, have a number of clients, bear the economic risk of loss from their work, and the like.

Workers who are economically dependent on the entity for whom they perform services generally should be treated as employees. Factors such as low wages, low skill levels, and having one or few employers should all militate against treatment as an independent contractor. A revised test based on the economic realities of the work relationship will eliminate the incentives to use the independent contractor form to evade the obligations of national workplace policy while leaving it fully available where its use is truly appropriate.

In order to create a consistent and rational policy on the definition of employees, Congress should change the tax law as well. Even if the definition of employee is simplified and standardized across employment and labor law, tax law will continue to present a significant incentive for misclassification if it goes unchanged. Two reforms are necessary in this area. First, Congress should apply an economic realities test for determining who is an employee to the Internal Revenue Code as well as to employment and labor law. Second, Congress should strengthen the IRS's ability to make sure employers and workers draw the line properly, whatever the test.

Currently, employers decide whether their workers are employees or independent contractors with little scrutiny from the IRS. Section 530 of the Revenue Act of 1978 ties the IRS's hands in attempting to deter misclassification. Section 530 prevents the IRS from collecting back taxes from an employer who misclassified its employees as independent contractors ~ or even from requiring the employer to reclassify the workers as employees ~ if any of three conditions are met: the employer's classification follows judicial precedent or IRS rulings; the classification is based on long-standing industry practice; or the employer has been audited by the IRS in the past without being assessed for the misclassification.

The past audit rule is indefensible as a matter of policy, because there is no requirement that the past audit looked into employment taxation. Thus, even if the employer was audited for something totally unrelated to the classifica- tion question, and the other two justifications for providing a safe harbor do not apply, the employer is free to misclassify employees indefinitely and avoid paying taxes it properly owes without penalty.

3. Eliminate the "Past Audit" Safe Harbor for Misclassification of Employees as Independent Contractors

Congress should reform Section 530 to permit the IRS to require an employer to reclassify an employee for the future any time the agency discovers an improper classification, regardless of past audits, if the employer's classification cannot be justified on the basis of accepted industry practice or tax law precedent. In addition, the IRS should be able to reclassify the employee for a limited period, such as up to three years into the past, if the agency has not audited the employer on the classification issue during that period.

2. The Definition of Employer

The definition of employer plays a role similar to the definition of employee in labor and employment law. Each statute sets out a definition of the employer concept which limits the scope of the statute's coverage by determining which entities are liable as employers and which are not. As with the employee concept, the employer definition varies from statute to statute. We believe it should be standardized and modernized in order to allow free play for mutually rewarding contingent relationships while eliminating incentives to create contingent relationships merely to evade legal obligations.

As a general rule, the definitions of employer are premised on a model of employment relations in which one set of employees is engaged in a continuing relationship with one enterprise. Thus, many federal statutes limit employer status to those parties responsible for hiring or firing, setting schedules, or actually issuing the worker's paycheck. This model of the employment relationship is badly out of date, not least because it fails to account for the extent to which contingent work arrangements have become commonplace rather than marginal in our society. Many thousands of workers are now employed by one firm but actually provide services for another as temporary, leased, or contract employees, and these relationships are often of short duration. Federal law should welcome this change, while ensuring that contingent relationships are established for the purposes of efficiency and flexibility, not to evade workplace standards

As the law now stands, the narrow definition of employer found in most employment and labor statutes gives firms incentives to create contingent relationships not for the sake of flexibility and efficiency, but to reduce the number of workers with access to collective bargaining and protections as to the minimum wage, overtime, pensions, benefits and the like. For example, Corporation A can create a subsidiary, Corporation B, and transfer to it work formerly done by Corporation A employees merely to avoid a collective bargaining agreement, as long as Corp. B has separate management and control over labor relations.

The incentives to use contingent forms to cut corners lead to harmful outcomes for American employers, workers, and society at large. Law abiding employers are undercut by contractors who can offer cheap services by avoiding minimum wage, Social Security, un-employment insurance, and other obligations. The economic security of workers is eroded, because the number of temporary and contract jobs is artificially inflated by socially harmful "cost savings." Many workers at the bottom of the employment ladder suffer under conditions that violate national standards of decency. For example, the GAO recently reported that sweatshops continue to be a major problem in the garment industry.<Footnote: United States General Accounting Office, Garment Industry: Efforts to Address the Prevalence and Conditions of Sweatshops, Nov. 1994 (GAO/HEHS-95-29).> The incentives to use contingent arrangements to avoid employment obligations create an unnecessary enforcement burden that state and federal governments are unable to bear and for which taxpayers should not have to pay.

The Commission believes the solution to this problem is not to reduce the ability of the buyers and sellers of labor to experiment with all manner of contingent relationships, but rather to remove the incentives to use those arrangements in ways that undercut national employment standards. In light of this policy, we make the following recommendations.

3. Modernize and Standardize the Definition of Employer Based on Economic Realities

The definition of employer in statutes across the employment and labor law spectrum should be changed and made uniform in a way that reflects the economic realities of the relation- ship between providers and recipients of services.

4. Expand "Single Employer" Doctrine

"Single employer" doctrine should be expanded so that firms do not have incentives to use variations in the corporate form to avoid workplace responsibilities. In general, a grouping of parent, subsidiary, sibling, and spin-off entities should be considered a single employer of their respective employees.<Footnote: One illustration of the single employer problem arising under labor law is the "double-breasted" contractor arrangement in the construction industry. A unionized contractor may establish a related or subsidiary contractor to do essentially the same kind of construction work but to do it nonunion, even though the firm was bound by a collective agreement through the original corporate entity. The Supreme Court has concluded that the current definition of employer under the NLRA is broad enough for the NLRB to hold the two corporate entities to be a single employer. South Prairie Construction Co. v. Operating Engineers Local 627, 425 U.S. 800 (1976). However, the Board generally has continued to treat the operations of related corporate entities in the construction field as separate bargaining units, with the unit designated by the firm as nonunion not having to meet the employment standards called for in the collective bargaining agreement. The Commission received extensive submissions on this issue. We recommend that the Board revisit the question of whether its policy continues to be appropriate in light of the Commission's broader judgments about the single employer doctrine.> In this area, the Internal Revenue Code can serve as a model for labor and employment law.<Footnote: See 26 U.S.C. 414.>

5. Expand "Joint Employer" Doctrine as to Safety and Health and Client Cancellation of Contracts

"Joint employer" doctrine should also be expanded, but not in a way that makes clients responsible for the actions of contractors over whose operations and employees they have little control. In client-provider relationships, the client firm should be liable to the provider firm's employees in two particular areas. First, because of the crucial importance of occupational safety and health, the client should be responsible for ensuring that its contractors meet the relevant legal standards regarding unsafe conditions or practices to which the workers may be exposed. Second, the client should be liable if its own decisions or actions with respect to the contract serve to deny the workers their legal rights under labor-relations law. .<Footnote: Thus, it should be a violation of the labor law for a client whose contractor's employees vote to unionize to terminate the contract as a result, since the client has effectively eliminated the employees' ability to choose collective bargaining. Indeed, the prospect of such a contract termination by an anti-union client ~ the risk of which the contractor can draw to the attention of its employees during the representation campaign ~ may prove a significant deterrent to the contractor's employees exercising their legal right to bargain collectively.>

The Commission also encourages the NLRB to use its rule making and adjudication processes to establish a fair doctrine governing joint-employer situations.

Previous Table of Contents Next