By: Diane Ring
Across the globe, policy makers are wrestling with the possibility that the nature of work is changing and that those changes might be positive or negative. One of the most prominent changes identified is the rise of “non-standard” work, essentially work that is not part of a traditional employer-employee relationship. The rise of the gig economy, and perhaps its even greater growth in the public imagination, have fueled concerns about the prospect of disappearing employment and its replacement with less stable and less desirable non-employee work options.
The degree to which this shift is taking place is an empirical question which has been difficult to pin down. As my co-author Shu-Yi Oei and I have explored in our paper, Tax Law’s Workplace Shift (forthcoming in the Boston University Law Review), data on the changing nature of work comes from empirical studies, which suffer from limitations due to the questions asked, the terminology employed, and comparability of studies over time and across databases. But regardless of any precise conclusions on the rate at which work is changing, there are valid reasons to be concerned and inquire about the impact of tax law on any such shifts. The OECD has begun to weigh in on these questions, releasing a new working paper entitled Taxation and the Future of Work: How Tax Systems Influence Choice of Employment Form, by Anna Milanez and Barbara Bratta (March 21, 2019).
The OECD Project
In this paper, the OECD tackles the question of whether tax considerations may be driving any increases in non-standard work. Using three labor scenarios—traditional employee, self-employed worker, and incorporated worker (e.g., a personal services corporation)—the paper asks how the tax burdens change across the three labor scenarios in eight test countries (including the United States).
In particular, the paper measures the “tax payment wedge” in each labor scenario in each country.
Payment wedge = total employment costs minus worker take home pay total employment costs
where total employment costs equal take home pay, income tax, employee social security contributions, employer social contributions, and payroll taxes minus any cash transfers (i.e. cash payments from the government to the worker, such as those made with respect to dependent children).
What did the OECD find across these eight test countries?
In some countries, the payment wedge was basically the same regardless of the form of work, but in other countries, the form of work mattered in the size of the wedge: that is, taxes really varied depending on whether the worker was an employee, self-employed, or incorporated. In the United States, Hungary, Italy, and Sweden, the size of the wedge for each labor scenario was relatively similar, whereas in the Netherlands and Argentina the size of the wedge differed significantly depending on the type of work arrangement. Focusing on Netherlands, the working paper identifies the key source of the difference: the Dutch tax system requires lower social contributions from self-employed workers (firms hiring them are not required to make any social contributions on their behalf). An annex to the working paper provides extensive detail on the tax law and payment wedge analysis in each of the eight countries studied.
The OECD envisions this paper as the starting point for further policy and empirical analysis of the impact of taxation and tax policy on work. It identifies a number of future questions, including whether tax differentials will greatly impact labor markets, whether tax law must respond to shifts in forms of work relationships, whether taxpayers will engage in arbitrage across worker categories, and how countries should conceive of the concept of neutrality in the taxation of workers.
Insights from the United States Experience
Drawing on the extensive work that my co-author and I have done in isolating and evaluating the precise mechanisms by which United States tax law contributes to and interacts with other factors in shaping U.S. work arrangements, I would highlight some specific issues for the OECD’s future study.
Different workers, different problems: First, it is crucial to distinguish the differential impacts tax law might have on work depending on the worker’s situation. As we’ve argued, for example, tax law might affect higher income and lower wage workers differently: (1) high income workers might be able to engage in strategic tax arbitrage across worker categories to their advantage, but (2) low wage workers might find the tax law could push them towards work relationships that are, on balance, less desirable. Thus, tax law’s impacts could hit differently situated taxpayers in different ways. The OECD does examine how the tax wedge may vary numerically by income level within a country. But it is equally crucial to reach beyond this calculation and to think about how differently situated taxpayers use and encounter a tax system and what that means for design options and reform possibilities. In the U.S. context, my co-author and I have particularly focused on the potentially serious implications for lower wage workers from shifts in the structure of work prompted by the tax and legal strategies that businesses have pursued to reduce their net costs from engaging workers. See here, here, here, and here.
Important complexity in income tax regimes: Second, the study of payment wedges for a hypothetical individual taxpayer working as an employee, as a self-employed person, or as an incorporated worker provides a valuable window on the degree to which the form of the work relationship matters for tax purposes. But failure to account more directly for additional income tax rules may disguise major tax differences across worker status. For example, if the worker’s (as opposed to the employer’s) ability to deduct their own work expenses varies by labor scenario (i.e., employee, self-employed, incorporated worker), the real payment wedges may be surprisingly different from those calculated without accounting for income tax treatment of expenses. As my co-author and I have discussed elsewhere, post-2017 tax reform U.S. tax law has suspended deductions for work-related expenses incurred by employees (but not the self-employed) until January 1, 2026. As a result, workers who typically incur significant expenses in the performance of their work (such as ridesharing drivers), might prefer to be classified as self-employed (i.e., independent contractors) in order to secure a potentially large tax deduction, despite the fact that such classification could result in the loss of current (or future) labor law benefits.
Tax decisions driving labor protections: Third, tax law incentives and disincentives to select (or accept) a particular work arrangement/labor scenario may drive worker classification across all legal regimes, not just tax. As Shu-Yi and I have detailed elsewhere, to the extent that workers and businesses do not typically engage in classification arbitrage across fields (for example, by claiming employment status under labor law regimes but independent contractor status for tax purposes), then a classification selected for tax will likely be the classification used for all legal regimes. If workers are fully informed about the impact of such choices, we might not worry. But if we believe there are reasons they may not appreciate the non-tax implications of their decision to accept work as an independent contractor because of its tax attractiveness, then we may be concerned about the influence of the tax system here and the “drag” it may create across fields. We model how workers might make such choices, even to their potential detriment.
Automation, robots, and globalization: Fourth, there are important connections between the choices we make in tax treatment of capital investments (e.g., equipment that displaces workers – often characterized as “robots taking our jobs”) and the future of work. If, as the OECD working paper notes, automation is one of the pressure points on labor then we should be thinking about how the taxation of work compares to the taxation of capital investments that can replace human labor. My co-author and I consider how certain tax and costs savings achieved by businesses through worker reclassification might serve as a brake on other forces pushing humans out of the U.S. labor force: If businesses are replacing employees with equipment in part because of the tax costs associated with employees, will such businesses be slower to shift to automation if workers are instead self-employed (assuming that status bears lower taxation)? In a similar vein, if workers shift to a lower taxed category, is there less incentive to move jobs offshore? Of course, a major factor in all of these assessments is the degree to which markets fully price in taxes (and other costs) as workers shift from one category to another.
Although the answers to questions about tax law, tax policy, and the future of work are deeply enmeshed in the social, legal and economic environment of individual nations, there are important trends, questions, and ideas that emerge from more global and comparative studies of the relationship between tax and work. The OECD’s working paper marks an important contribution to global efforts to understand these questions and develop beneficial policies.