The Gig Economy: Bittersweet Romance

The romance of being your own boss is exciting. However, it likewise is necessary to be aware of the costs, including the fact that you also must be an accountant, a marketing manager, and your own employee.

The gig economy has been in the news frequently in the last few years—first because of its increasing growth and then because of the hard hit it has taken from COVID-19 and the resulting nationwide business closures in the last two months. In 2020, prior to the onset of the Coronavirus pandemic, the size of the gig economy was estimated to be more than 43 percent of the available workforce, including people who work full-time as contractors and those who have part-time projects. Contract employment allows workers schedule flexibility, additional income, and more job opportunities. Gig work goes hand in hand with the romantic idea of being your own boss, choosing projects you want to work on, and determining how much you want to get paid. For some, gigs can be a breath of fresh air in their daily routine; for others, it is an important supplement to their full-time employment.

As with all romantic ideas, gig work often is portrayed as filled with rainbows and butterflies, omitting its hidden costs and associated risks. Whether you are a full-time contractor or someone looking for additional income part-time, you need to be aware of not only the benefits of the gig economy, but also its costs. The costs of the gig economy may be less obvious than its benefits, but they are no less significant. And if you decide to join the freelance workforce, you need to do that with your eyes wide open.

Gig Growth

The gig economy is not new; the concept of gigs was developed at least a century ago. Originally coined by jazz musicians in the 1920s, a gig was a musical engagement for one night only. Today, however, it has become a mindset for work, as freelancers and contractors apply the term, “gig,” to their projects, regardless of the length of those assignments. In the U.S., the gig economy grew from 10.1 percent of the workforce in 2005 to 15.8 percent in 2015. It is expected to include close to half of the available workforce in 2020.

Why has the gig economy continued to grow? As with any classic economic question, the answer is supply and demand. Growth is fueled by the demand from employers who lack the skills in their current workforce. As technology develops and the skill gap widens, companies bridge the skills gap by attracting contractors with the required skills and experience. Prior to the pandemic and subsequent state lockdowns and business closures, it was estimated that in 2020, the United States economy would have a deficit of 1.5 million workers with a college degree, and 6 million workers with a high school diploma. Employers were striving to reduce costs and gain workforce elasticity by expanding and shrinking the workforce with the market. Supply for the gig economy is driven by employees who are looking for independence, work-schedule flexibility, and greater job opportunities.

Worker Misclassification

The benefits of flexibility and independence are major factors for gig workers. The cost savings are often a deciding factor for companies engaging the contractors. However, the real costs of the growing gig economy are less obvious.

Much of the United States’ workforce policies and social safety net were developed in the mid-20th century when the “work at one company until retirement” practice was the standard. As a result, policies were designed for full-time employees, leaving contractors without benefits. The hiring company does not pay employment taxes, including Social Security/Medicare, and unemployment taxes for contract workers (the Federal government has provided Pandemic Unemployment Insurance to qualified workers as the Coronavirus continues to spread). Contractors are not by law guaranteed a minimum wage. According to the State of California, the independent contractor “has no worker’s compensation coverage if injured on the job, no right to family leave, no unemployment insurance, no legal right to organize or join a union, and no protection against employer retaliation.”

These antiquated workforce policies encourage companies to cut costs by misclassifying employees. Employee misclassification is a practice that allows employers to avoid paying unemployment taxes or provide worker’s compensation and unemployment insurance by labeling them as independent contractors rather than employees. Employee misclassification is not new; however, its use has increased since September 2019, after California passed Assembly Bill (AB) 5.

AB5 targets misclassification of workers by adopting the “ABC” test, which uses three criteria to determine if a worker can be classified as an independent contractor. The ABC test determines:

A. If the worker is free from the control and direction of the hiring entity in connection with the performance of the work.

B. If the worker performs work that is outside the usual course of the hiring company’s business.

C. If the worker is customarily engaged in an independently established trade or occupation of the same nature as the work performed.

According to the State of California, the misclassification of workers resulted in an estimated loss of $7 billion per year in payroll tax revenue to the State. After passing the AB5 bill, other states also considered the costs of worker misclassification. According to the report issued by researchers with the Harvard Law School’s Labor and Worklife Program, between 2013 and 2017, the State of Washington lost $152 million in unemployment taxes and nearly $300 million in payroll taxes for Social Security and Medicare, as well as $9 million in federal unemployment tax. The same study found that misclassification of workers can produce savings of up to 30 percent in labor costs for the hiring company.

By misclassifying workers, companies are simply transferring their costs to their contractors. As a result, those contractors are fully responsible for covering payroll taxes out of their paychecks. Based on the legal structure the contractor chooses, the unemployment tax also can be added to the required payments. You might ask how the State loses money if the contract employees are supposed to pay the full share of the taxes. One way is by underreporting income. Another is the complexity of the tax system. Contractors are responsible for filing their own taxes, but many do not fully understand what is required of them. For example, personal employment tax can account for an additional 15.3 percent of the contractor’s earnings. Not everyone can set aside 20 percent to 30 percent of their income every month for tax purposes, and certainly not everyone is a CPA.

This presents one of the biggest challenges for gig workers—that their financial life gets a lot more complicated. Now, not only are you your own boss, you are also an accountant and an operations manager. Since becoming a contractor significantly increases your costs, it is crucial that you price your work accordingly. When pricing their work, many people look at the total revenue figure rather than the net. When estimating the price for your work, remember to subtract the fixed costs, such as taxes and health insurance, as well as variable costs involved in performing the work. After doing so, look at the net amount and decide if it is enough for you.

Another important factor for gig workers to consider is the lack of stability and ambiguity, and the increased stress that can bring. Marketing and sales are often a make-or-break factor for gig workers. You no longer have a manager to give you a next assignment; there is no pipeline of work automatically coming in. Remember, you are now your own boss. While working on your current gig, you need to continue to market yourself and look for your next opportunity. You should never have only one project with one employer in mind. Many freelancers make the mistake of devoting 100 percent of their time to one project and forgetting to reach out to more clients.

We’ve noted the personal financial impact to the gig worker, but it is also important to look at the bigger picture. State revenue is spent on education, building and repairing roads, providing health coverage to low-income families, and public assistance. On average, more than half of State spending is on education (K-12, higher education) and healthcare. Loss in payroll tax revenue to the State means less money is available to spend on education and healthcare benefits for low-income children, elderly people, and people with disabilities. Companies avoid paying taxes by hiring gig workers, and those gig workers carry the full load by paying for Social Security and Medicare out of their paychecks. Those same contractors who are denied access to work-based protections increase their reliance on the public safety net, which receives less funding in a gig economy.

Be Aware of Costs and Benefits

The benefits of the gig economy include work flexibility, independence, and a greater variety of opportunities. These benefits come at a cost—no employee protection, full responsibility for taxes, loss of State income tax revenue, and decreased funds for schools and healthcare systems. Workers entering the gig economy should not only consider the benefits but also be aware of the costs. The romance of being your own boss is exciting. However, as with any romance, it is bittersweet. Not only are you now your own boss, you are an accountant, a marketing manager, and your own employee. You must understand the costs to obtain the benefits.

As a nation, we need to accept the fact that our workforce landscape is changing. The standard is no longer one job until retirement. Considering our present workforce needs, our legislation must change as we head into the future.

Veronika Shestakova, MS in Finance, specializes in risk management and investment management. She has worked with Eurex Exchange and HSBC Bank. Shestakova has experience with research, statistical analysis, analytics, and modeling, including Machine Learning models. Areas of research include artificial intelligence (AI) and macroeconomic trend analysis.

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