How U.S. Law Needs to Change to Support the Self-Employed and Gig Economy
If we were designing a labor market from scratch today, it’s unlikely we’d create one that rewards only full-time employees. It wouldn’t make sense given the many ways that people choose to — or must — work: independently, part-time, on the side, as a contractor or freelancer, or on-demand. The U.S. has a long history and narrative of supporting entrepreneurship, yet its tax and labor policies reward full-time employees in full-time jobs, and penalize everyone else. To remedy that, policymakers need to consider eliminating the Self-Employment Tax and extending employee tax breaks and protections to all workers.
If we were designing a labor market from scratch today, it’s unlikely we’d create one that rewards only full-time employees. It wouldn’t make sense given the many ways that people choose to — or must — work: independently, part-time, on the side, as a contractor or freelancer, or on-demand. An estimated 30-40% of today’s workforce are self-employed either part- or full-time, and the numbers are only expected to grow. If we were designing a labor market today, we’d create a system that supports everyone who works.
Yet, in the U.S. our tax and labor policies reward full-time employees in full-time jobs, and penalize everyone else. We have created a labor market that funnels workers to a singular destination: the cubes and office parks that are the mandatory encumbrances of a full-time job. Those who deviate from this path, whether by choice or circumstance, are taxed additionally, then stripped of the benefits, rights, and protections that are only available to employees in traditional jobs with a single employer.
The U.S. has a long history and narrative of supporting entrepreneurship. We praise individuals who strike out on their own, become their own boss, or start a company. We talk about the importance of entrepreneurship and small businesses to our economy, and we say we value the risks entrepreneurs take to create new opportunities.
But the emergence and rapid growth of the Gig Economy — made up of independent contractors, consultants, freelancers, and on-demand workers — is exposing the glaring disconnect between the entrepreneurial work our country says it values and the full-time jobs with a single employer that our tax and labor policies actually support. Independent workers who take the risk to start their own business quickly realize that the consequences of doing so are higher taxes, and fewer benefits and protections.
Creating a labor market that supports everyone who works requires extending the benefits and protections awarded to full-time employees to all workers. It’s a monumental undertaking, but a necessary one if we want to walk the talk of supporting entrepreneurs and if we want to maximize the potential of our increasingly self-employed and independent workforce.
There are many ways to start updating our labor market and tax policies to include our entire workforce. To start, there are three meaningful policy changes that will get us closer to creating a labor market that supports everyone who works.
It is U.S. policy to specifically, separately, and additionally tax people who take the risk to become their own boss. Think of it as an Entrepreneur Tax that is levied on everyone who works for themselves, even if it’s just a side gig in addition to a full-time job. It’s a paradox to say we support entrepreneurship, then tax people for starting their own business.
In the U.S., employers and employees split the bill for Social Security and Medicare, through what are known as “payroll taxes.” However, through what is aptly named the Self-Employment Tax, self-employed individuals have to pay not only the employee side of Medicare, and Social Security taxes, as employees do, but also the employer side. The tax of 15.3% is levied on everyone who works independently, whether by choice or circumstance, whether full-time, or through a side gig. The Tax Cuts and Jobs Act passed last year left the Self-Employment Tax unchanged (though after the tax is paid it provides for a deduction of 20% of qualified business income for some business that qualify). The end result is that all independent workers pay double the Medicare and Social Security taxes that full-time employees do.
Entrepreneurs deserve the support of our tax policies, not the penalty of an additional dedicated tax. There are many options for replacing the revenue from this tax, and a robust discussion of them is worth having. One approach is to require employers to pay the employer side of Medicare and Social Security taxes for all workers they hire, not just employees. This option leverages an administrative system and processes already in place at most companies. It also offers the added benefit of increased tax compliance (and therefore, revenue) as the responsibility for paying the tax would be shifted from independent workers to employers.
Another possibility is to eliminate the tax entirely and replace the revenue by incrementally reducing the unrestrained and uncapped federal government tax subsidies on employer-provided health insurance.
Health insurance is the most critical benefit to workers. Yet, only full-time employees in a full-time job with one employer benefit from the lavish set of tax breaks the federal government bestows on employer-provided health insurance. It’s difficult to create a compelling policy argument for continuing to target such extensive and expensive tax breaks only to full-time employees when a growing part of the workforce pursues independent and self-employed work.
Federal favoritism towards employees is clearly evident in the numbers. The tax breaks that benefit full-time employees total about $300 billion annually compared to the $7 billion in breaks awarded to independent workers.
The list of tax breaks awarded to employer-provided health insurance is long. Employers don’t have to pay payroll taxes on the value of the health insurance they provide, and they can deduct the cost of premiums as a business expense. Employees don’t pay income or payroll taxes on the value of the insurance coverage they receive from their employer. They also can often pay for their portion of the insurance premiums with pre-tax dollars, which reduces their taxable income, which, in turn, reduces their income and payroll taxes further.
Anyone who isn’t an employee is excluded from the $300 billion in government largesse. The insurance premiums independent workers pay are not deductible as a business expense and are paid with after-tax dollars, including payments of federal and state taxes, as well as the Self-Employment Tax. The one small break independent workers are awarded is the ability to deduct the cost of their health insurance premiums from their personal taxable incomes.
For now, Gig Economy workers are camped out under the umbrella of the Affordable Care Act. The ACA is far from perfect. The availability and affordability of insurance options varies tremendously by geography, and choices in smaller markets can be very limited and relatively expensive. But, even with its imperfections, the ACA has been critical to the economic security of self-employed and independent workers because it has separated the ability to obtain health insurance from the need to hold a full-time job.
There are numerous ways to distribute the federal subsidies of private health insurance across the entire workforce, and this is also a conversation worth having. One approach is to reduce the tax breaks awarded to employers — by setting an upper limit on their business expense deduction for health insurance or collecting payroll taxes on the value of the insurance coverage they provide — and re-allocate those savings to extend tax benefits to entrepreneurs and independent workers.
Another option is to actually implement some version of the twice-delayed ACA “Cadillac Tax,” which imposes a 40% excise tax on employers who provide high-cost health insurance plans with premiums that exceed specific thresholds. The revenues from that tax could be targeted towards extending tax breaks and lowering the premium costs for individually purchased health insurance.
Our labor market provides a number of protections to mitigate the power and control employers can exert over employees. Some protections make little sense to extend to self-employed independent workers who decide when, where, and how much they work, but two that do are income protection, and protection against harassment and discrimination.
Income protection. Unemployment insurance works when everyone has a traditional job with a single employer. It falls apart in an economy where “employment” consists of a portfolio of gigs, projects, and assignments conducted for multiple clients. A growing percentage of today’s workforce doesn’t need unemployment insurance if they lose a job, because they don’t have a traditional job. They need income insurance if they lose a significant amount of work. The basic idea of income insurance is the same as unemployment insurance: to provide a minimum level of financial stability without removing incentives to sensibly manage risk.
Traditionally, when an employer terminates an employee through no fault of the employee — due to a layoff or merger or downsizing — the employee’s financial stability is protected by unemployment insurance, which pay employees a percentage of their prior income for a period of time (usually about six months). Employers pay the costs of unemployment insurance through regular payments to their state’s unemployment insurance fund.
Entrepreneurs who work for themselves can also experience significant or persistent declines in income through no fault of their own, but there is no financial protection available to them.
Income protection could provide self-employed and independent workers with a percentage of their former income for a defined period of time, just like unemployment insurance does for employees. One approach to creating income protection is to require companies to pay pro-rata income protection payments for all their workers, not just employees. Employers in many states already pay unemployment insurance on a pro rata basis for part-time employees. Under this option, they would be required to extend their pro-rata payments to cover all their workers, regardless of employment status.
Protection against discrimination and harassment. In the long, dark shadow of the #MeToo movement, it’s hard to believe we continue to support a labor market in which being treated as a human being, not an object of sexualized attention, is legally protected only if you’re an employee.
The right to work in an environment free from harassment and discrimination is not currently extended to independent workers. If you leave full-time employment, even if you return to work for the same employer as a consultant or independent contractor, you relinquish those protections. Our existing regulations allow employers to discriminate against or harass independent workers for any reason (including gender, age, sexual orientation, and race).
It is a relatively straightforward change in policy to extend discrimination and harassment protections to independent workers. In a promising first step towards covering all workers, Congresswoman Eleanor Holmes Norton (D-DC), the chair of the U.S. Equal Employment Opportunity Commission, introduced a bill to apply federal anti-discrimination protections to independent contractors. This, or similar legislation, is needed to extend basic employee protections to all workers.
Labor and tax policies that support only full-time employees in a full-time job with a single employer make less and less sense for a workforce that is increasingly entrepreneurial and independent. If we want to walk the talk of supporting entrepreneurs who strike out on their own and work for themselves, we need to consider eliminating the Self-Employment Tax and extending employee tax breaks and protections to all workers. These are significant but necessary undertakings to create labor and tax policies that work for everyone who works.
Diane Mulcahy is the author of The Gig Economy: The Complete Guide to Getting Better Work, Taking More Time Off, and Financing the Life you Want. She is an Adjunct Lecturer at Babson College, where she created and teaches an MBA course on the Gig Economy, and a Senior Fellow at the Ewing Marion Kauffman Foundation. Learn more about Diane’s work at www.dianemulcahy.com.
How U.S. Law Needs to Change to Support the Self-Employed and Gig Economy
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