November 30, 2020
On November 3, 2020, California voters approved several ballot initiatives including Proposition 22, which exempts online-enabled applications and platforms (such as Uber, Lyft, Postmates, DoorDash and Instacart) from a state law intended to provide full employee protections to certain service providers (including many gig-workers) who may have been classified as independent contractors. Nearly 60 percent of voters—over 9 million Californians—voted in favor of Proposition 22, potentially setting the tone for gig-worker regulation for the rest of the country.
More locally, voters in the City of San Francisco approved Proposition L, which imposes an additional tax to be known as the “Overpaid Executive Gross Receipts Tax” on companies where the top executive’s pay is 100 or more times its median employee pay. Proposition L passed with 65 percent of the vote, making San Francisco the first U.S. city to impose a tax on both private and public businesses based on an executive pay ratio.
Uber, Lyft and other app-based services proposed Proposition 22 as a response to California Assembly Bill 5 (AB-5), which limited an employer’s ability to classify workers as independent contractors by requiring that employers prove the workers’ duties are outside the employer’s regular business. Under state and federal law, workers who are classified as employees are afforded specific protections under minimum wage and other wage and hour laws, and, through this, employees receive social security contributions, workers’ compensation coverage, and in many cases paid time off and benefit plan eligibility. In contrast, independent contractors are not generally entitled to, and the companies they provide services to generally need not provide, those benefits and protections granted to employees under the law and its employee benefit plans.
After AB-5 took effect on January 1, 2020, Uber and Lyft argued that they were not required to reclassify their drivers as employees, taking the position that because they are, at essence, technology companies, the drivers’ duties are outside Uber and Lyft’s “regular business.” The California Attorney General and city attorneys for San Francisco, San Diego and Los Angeles sued Uber and Lyft in May 2020, seeking an order to make the ride-hailing companies reclassify their drivers under AB-5. On October 22, 2020, a California appellate court unanimously upheld an earlier order requiring Uber and Lyft to reclassify their drivers as employees.
The subsequent passage of Proposition 22, which adds a new chapter to the California Business and Professions Code and amends a section of the California Revenue and Taxation Code, may free Uber and Lyft from the appellate court’s order, as it exempts online-enabled ride-hailing and delivery applications and platforms from compliance with AB-5 if certain conditions are met.
Proposition 22 prohibits app-based services from unilaterally prescribing dates, times or the minimum number of hours a driver or delivery person must work. App-based services similarly cannot require that drivers accept specific service requests or restrict drivers from working for other app-based services or another occupation or business. Proposition 22 also requires that app-based services provide drivers and delivery people with certain guarantees, such as a net earning floor, medical benefits and insurance coverage, and the development and implementation of sexual harassment policies, driver safety training and a termination appeals process. Failure to comply with any of these requirements may risk claims similar to those brought against Uber and Lyft under AB-5.
California Assemblywoman Lorena Gonzalez (D — San Diego) authored AB-5 and has since promised the fight isn’t over. Similarly, labor groups that opposed Proposition 22 are considering next steps such as lobbying the incoming presidential administration’s Department of Labor to issue stronger federal rules for worker classification, pursuing a 7/8 supermajority in the state legislature to amend the measure or suing over specific provisions in the measure, such as its preemption of local law or its ban on driver collective bargaining.
Proposition L, which amends the City of San Francisco’s Business and Tax Regulations Code, creates a new tax on both public and private entities doing business in the City of San Francisco if the entity’s highest-paid managerial employee earns 100 or more times the median compensation paid to the entities’ full and part-time employees who are based in San Francisco.
The executive pay ratio is calculated by comparing the annual compensation paid to an entity’s highest-paid employee or officer with managerial responsibility in a business function for a tax year to the median compensation paid to the entity’s full and part-time employees based in San Francisco for that tax year on a full-time equivalency and annualized basis. For the purposes of the tax, “compensation” includes wages, salaries, commissions, bonuses, property, stock options and “any other form of remuneration paid to employees for services.” Additionally, an employee is considered to be based in the City of San Francisco if her total annual hours worked in San Francisco exceed those worked in any other jurisdiction. Proposition L does not provide any further guidance on how to calculate the median San Francisco-based employee salary.
The tax will be imposed beginning January 1, 2022 and will be based on the executive pay ratio from the prior calendar year. The tax will levy a charge equal to 0.1 percent to 0.6 percent of gross receipts, increasing in 0.1 percent brackets proportionally to the pay ratio. Therefore, a company with a highest-paid managerial employee earning 200 times its median City of San Francisco-based employee will be charged 0.2 percent on its gross receipts, 300 times more results in a 0.3 percent charge and so on, maxing out at 0.6 percent.
Any entity engaging in business within San Francisco as an “administrative office” as defined in Section 953.8 of Article 12-A-1, will instead be subject to the executive-to-employee pay ratio tax as measured by total payroll expenses attributable to San Francisco. For these organizations, the new tax that will be levied will be equal to 0.4 percent to 2.4 percent of total payroll expenses, increasing in 0.4 percent brackets proportionally to the pay ratio. If an entity is subject to the tax as a measure of its total payroll expenses, it is not also subject to the tax as a measure of its gross receipts.
The ballot initiatives’ successes demonstrate the California electorate’s high level of engagement with its scrutiny of employment issues. Furthermore, Proposition 22’s success represents Californians’ willingness to supersede their elected officials on matters of employment classification, wages and benefits.
Proposition 22’s election day victory casts doubt on states’ abilities to regulate gig-workers’ statuses and on the electorate’s appetite for such reclassification. States such as New York, which passed a minimum wage for ride-hailing drivers in 2018, Oregon and Washington were each closely watching the legal battles in California. Such states may now be more wary about quickly pursuing worker reclassification legislation similar to AB-5, because legislative attempts to extend employee protections to workers classified as independent contractors may be overridden by voter referendums.
While Uber, Lyft and other app-based services are now generally exempt from AB-5’s classification requirements, other companies remain bound by its provisions. The California Attorney General and attorneys representing cities throughout the state have already demonstrated their willingness to use the courts to enforce AB-5’s requirements. Other companies that may not yet be in compliance with AB-5 should look to Uber and Lyft’s loss in court rather than their win at the ballot box as a harbinger for the future of AB-5 enforcement.
Similarly, Proposition L’s success demonstrates San Franciscans’ interest in regulating income disparity. The tax imposed by Proposition L is not the first of its kind, but it is the first to apply to both public and private companies. In 2018, the City of Portland, Oregon imposed a similar tax on public companies based on pay ratios as reported to the SEC. As a result, Proposition L’s success may embolden other cities to enact a similar tax regime.
In the interim, companies doing business in San Francisco should begin to consider the tax’s implications on future hiring of San Francisco-based employees and on future executive compensation determinations. Companies should also review existing employment relationships with full-time, part-time and seasonal employees to determine their impact on this potential tax liability.
Special thanks to Shearman & Sterling Law Clerk Eitan Morris for his contribution to this client publication.