This piece was co-authored by R Street Editor-in-Chief and Senior Fellow R.J. Lehmann.

One of the underappreciated problems of the growth of the regulatory state is that rather than clarifying the rules of the road for companies and consumers, regulations often simply beget more regulations. A textbook example can be seen in the evolution of so-called “sharing economy” firms, and how they are treated by both regulators and the courts.

As transportation network companies (TNCs) like Uber and Lyft have continued to grow in popularity, a growing list of states and municipalities – including California, Colorado, Illinois, and the District of Columbia, with dozens of others to come – have passed basic regulatory frameworks that, in some cases, have nudged the companies away from their original business models. To remain in regulators’ good graces, TNCs have agreed to conduct background checks on their drivers, confirm that vehicles have undergone safety inspections, and provide extensive liability insurance to cover drivers any time they are on the clock and, in some cases, even when they aren’t.

But in a cruel irony, acquiescing to the very rules that have helped make ridesharing palatable to regulators could ultimately be used against the companies in a pair of class actions currently pending in U.S. District Court in San Francisco. The suits hinge on whether drivers for these platforms ought to be considered employees or independent contractors.

The decision could have serious implications for the companies’ bottom lines. If the ridesharing platforms are defined as “employers,” they’ll have to shell out for workers’ compensation coverage, gas and maintenance expenses, payroll taxes, unemployment insurance, and potentially even health, retirement benefits, and in some states, paid leave benefits. Under the California Labor Code, which is even more stringent than federal Department of Labor rules, the companies could face stiff fines if they fail to keep detailed paperwork on the drivers’ wage statements, and even steeper penalties if they failed to provide appropriate overtime or meal and rest breaks.

The TNCs certainly have a plausible case that their drivers ought to be considered independent contractors. Ridesharing drivers set their own hours of work and own their own cars. They start work when they want and can quit without notice. Many drivers actually work for multiple competing TNCs simultaneously. None of these things is consistent with a traditional employer-employee relationship.

On the other hand, there is the risk that courts could determine that in stepping up to agree to abide certain basic, reasonable regulations, like screening and insuring their drivers, the TNCs have inadvertently tiptoed over the threshold of “control” used by federal agencies like the Department of Labor and IRS to define who is an employee and who is a contractor.

Such a finding would be unfortunate, as it would hurt those who benefit most from the sharing economy — workers wanting to try a new job or make extra money on the side. Raising the costs of operating a sharing economy platform would constrict demand for the sorts of part-time “gig” workers who have made these services the successful ventures they are. It also would serve as a red flag, warding off future entrepreneurs who might bring to market new ways to unlock trapped capital, both human and financial.

Perhaps most troubling is that a ruling against the ridesharing companies could serve as precedent for future suits that target other forms of sharing economy services. (Leaders of at least two other major sharing economy companies outside of the ridesharing space told one of us they already are concerned about similar lawsuits.) That’s why these cases deserve careful scrutiny.  If the courts fail to see how the flexibility inherent in the sharing economy benefits workers, companies and consumers, it might be time for Congress to revisit these rules. Otherwise, a dynamic new market could end up being smothered while its still in the cradle.

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