Worker misclassification cheats workers, burdens taxpayers, and exacerbates “race to the bottom” conditions

Misclassification occurs when employers hire workers as independent contractors instead of employees in order to circumvent labor laws, payroll taxes, and other responsibilities. Although both employees and independent contractors provide labor in exchange for compensation, the nature of their relationships with employers differ significantly (see Table 1). True independent contractors are generally in business for themselves, work with multiple clients at a time, and exercise a high degree of control over when, where, and how often they will work on a contracted project. Employees, on the other hand, are generally subject to work schedules, tasks, and conditions determined by their employers and do not interact with their employer as a separate independent business.

Because employees tend to have less autonomy and independent decision-making power than independent contractors, they are covered by many workplace rights and protections that independent contractors are exempt from. Misclassification therefore has far-reaching costs for individual workers, but it also has detrimental effects on construction industry labor standards and taxpayers more broadly.

Kelly Miller is a Research Associate at Movement Economics with expertise in US labor and workplace policy. 

Construction workers who are misclassified as independent contractors often face reduced workplace rights and protections and less financial security during challenging times, such as unemployment or injury recovery.

Because independent contractors are not considered “employees” under the Fair Labor Standards Act (FLSA), workers who are misclassified as independent contractors are not entitled to overtime pay or a minimum hourly wage. As a result, misclassification in the construction industry also contributes to rampant wage theft and underpayment. The Century Foundation estimates that misclassification and cash-in-hand payments cost construction industry workers $1.9 billion in overtime pay in 2021. Consequently, independent contractor status can bar workers from seeking restitution for unpaid wages. The official minimum wage violation reporting processes in many jurisdictions do not allow independent contractors to file complaints.

The harm caused by misclassification reaches beyond individual workers, impacting the economic security of their families and children. A 2014 report by the Economic Roundtable found that the families of misclassified California construction workers and construction workers who were paid off the books were three times more likely to live in poverty. This finding highlights how misclassification forces more families to depend on social programs to meet basic needs while simultaneously undermining those programs by reducing the tax revenue that funds them.

Workers misclassified as independent contractors are also not typically covered by workers' compensation or unemployment insurance. These exclusions can be especially detrimental to construction workers because of the nature of their work.

Construction poses a greater threat of on-the-job injury than most other industries. Our analysis of California regulatory filings (WCIRB 2026) found that while construction occupational classifications account for only a 5.7 percent share of recent total reported payroll (or “exposure”), construction jobs account for two-and-one-half times as large a percentage of total workers compensation insurance losses (14.2 percent) and over three-times as large of a percentage of reported serious claims (18.0 percent). Construction workers who are illegitimately denied access to workers' compensation insurance are therefore at high risk of incurring significant personal medical expenses and income losses.

In addition to extraordinarily high exposure to physical & economic risks from injury, construction workers also are exposed to greater economic risk due low “attachment” to individual employers. Employees in the construction sector experience higher layoff or discharge rates than other private sector employees, according to BLS JOLTS data. Jobs may only last for the duration of a single project or become sparse during times of extreme weather. Without access to unemployment insurance, misclassified construction workers may find themselves suddenly without any income.

Finally, being misclassified denies workers protection from discrimination and sexual harassment at work. Independent contractors are not covered by any of the federal workplace anti-discrimination laws that are enforced by the Equal Employment Opportunity Commission (EEOC).These include Title VII, which outlaws discrimination based on race, sex, religion, or national origin, the Americans with Disabilities Act (ADA), the Equal Pay Act of 1963, and the Pregnancy Discrimination Act. Misclassified workers therefore have very limited legal recourse if they experience discriminatory treatment on the job and may feel forced to put up with hostile workplace climates.

When construction employers misclassify their workers as independent contractors instead of employees, it is generally in an attempt to increase their profitability and competitiveness by minimizing their labor costs. Misclassification can lower an individual employer’s expenses by allowing them to dodge payroll taxes and overtime pay and minimum wage obligations. The Century Foundation estimates that California construction employers avoided $1.4 billion in expenses by misclassifying workers in 2021 alone. This amount was the highest out of all fifty US states.

In addition to being unfair to workers, such practices contribute to deteriorating conditions across the construction industry. Because they spend less on overtime, taxes, and workers compensation insurance, employers who engage in misclassification are able to submit lower bids for construction project contracts. This makes it difficult for scrupulous employers who correctly classify their workers to compete; they face pressure to either adopt the same low-road practices or risk going out of business. Misclassification therefore propels a “race to the bottom” where construction job standards continue to decline. Unless regulatory agencies make a diligent effort to investigate and strongly penalize misclassification, the practice will remain profitable and therefore prevalent.

There is also significant evidence that misclassification harms California’s construction industry employers through workers’ compensation fraud. A 2007 study by UC Berkeley researchers for the The California Commission on Health and Safety and Workers’ Compensation found that payroll fraud– which includes misclassification– increased workers' compensation premium rates significantly for California employers in high-risk industries. This illustrates how misclassification fuels a vicious cycle: when employers evade their fair share of industrial insurance contributions, it drives up premium costs, further encouraging fraudulent practices to cut expenses. Such cycles also put honest employers at a competitive disadvantage.

Another of the main reasons employers misclassify workers is to avoid their payroll tax obligations. Misclassification deprives vital social insurance and welfare programs of funding while simultaneously increasing the likelihood that workers will need to rely on them to make up for lower take-home pay and fewer job-based benefits and protections.

In the United States, unemployment insurance, Social Security, and Medicare receive significant portions of their funding from employer-paid payroll taxes. However, when an employer’s workers are classified as independent contractors instead of employees, this tax burden is shifted to the workers themselves. The Century Foundation estimates that misclassification shifts a total national tax burden of at least $5.1 billion from employers to employees each year. Additionally, employers who engaged in misclassification caused state unemployment insurance funds to lose $791 million in 2021.

Various studies have also revealed the heavy burden that misclassification in the construction industry imposes on California taxpayers specifically. The Economic Roundtable estimates that, in 2011, construction worker misclassification cost California $473 million in lost tax revenue. The Century Foundation estimates that this figure had increased to over one billion by 2021.

Employers can also use misclassification to shirk their mandatory contributions to workers' compensation insurance. The amount that an employer must pay each month in workers’ compensation premiums is affected by the number of employees on their payroll and the job classification of those employees. Misclassifying employees as independent contractors can artificially reduce employee counts, thereby lowering an employer’s premiums. The Century Foundation estimates that American construction employers avoided paying $5 billion in workers' compensation premiums in 2021 by misclassifying their workers.

To address the harms of worker misclassification, California has taken a significant step by adopting the ABC test to determine whether workers qualify as employees or independent contractors under wage and hour laws, unemployment insurance rules, and workers’ compensation eligibility. The ABC test is a three-pronged inquiry into the nature of a worker’s relationship with their employer. To be classified as an independent contractor, a worker must (1) have control over the direction of their work performance; (2) do work that is outside the usual scope of the employer’s business; and (3) have their own independently established business of the same type as the work performed. Unless all three of these statements apply to a given worker, they cannot be classified as an independent contractor under California’s Labor Code. 

Since the 2019 passage of AB 5, which codified the ABC test as state law, the share of California workers that report working as independent contractors at their main job has declined from 9 percent in 2018 to 7 percent in 2024 (see Figure 1). The share of construction workers that are independent contractors at their main job has dropped more, from 17 percent in 2018 to 13 percent in 2024.

California law also prohibits independent contractors from accepting contracts over $1,000 if they are not licensed by the Contractors State License Board. The CSLB’s investigative fraud team enforces this rule by conducting regular construction site sweeps. This rule and its enforcement strategy represent a simpler and proactive way to catch employers engaging in misclassification.

Despite these gains, misclassification remains a significant issue in the California construction industry. Authors of a 2023 Century Foundation study found that 13.9 percent of California construction workers were misclassified as independent contractors. This represents a misclassification rate of more than one in seven workers. The researchers cautioned that the true rate may be even higher– the large population of undocumented immigrant workers in California likely contributed to an undercount of construction workers in their dataset. 

Table 2 presents this author’s rough estimate of the current number of misclassified construction workers in California. We derive this estimate by comparing two figures: (1) the number of self-employed, unincorporated workers in the construction industry reported in the 2024 American Community Survey, and (2) the number of unincorporated contractors holding active California State License Board (CSLB) licenses who report an exemption from workers’ compensation coverage. Because the vast majority of contractors who qualify for workers’ compensation exemptions have no employees, the count of licensed, workers’ compensation–exempt contractors serves as a reasonable proxy for properly classified independent contractors. The difference between these two measures suggests that up to 77,000 construction workers in California may currently be misclassified as independent contractors. Expressed as a share of the Occupational Employment and Wage Statistics’ 2024 estimate of total construction employment in the state, this corresponds to a misclassification rate of approximately 11.8%. 

Our estimate and the findings of the Century Foundation study suggest that the adoption of the ABC test alone has not been enough to eliminate misclassification; stringent and strategic enforcement is also needed to protect the most vulnerable workers. California workers who suspect they have been misclassified as independent contractors can file a Request for Preliminary Classification form with the Employment Development Department (EDD). This form can either initiate an audit of the violating employer or simply ask the EDD to issue an opinion on the worker’s case. Workers who request an audit risk having the details of their complaint shared with their employer, while workers who request an opinion are encouraged to share it with their employer to prompt voluntary compliance. Workers may be reluctant to pursue either of these options due to fear of employer retaliation, particularly if they are undocumented or facing economic hardship. An extensive body of research demonstrates that labor violation complaint rates tend to be lowest in industries and workplaces where violations are most pervasive. To prevent this trend from stifling misclassification reports in the construction industry, California’s labor agencies could prioritize proactive investigations into high-risk employers, like they did in the case of RDV Construction in 2019. As a result of a payroll audit conducted by the California Labor Commissioner’s Office, RDV Construction was ordered to pay nearly $12 million in compensation to more than 1,000 misclassified workers.