Since President Obama announced a bold update to the rules determining who gets overtime pay, a variety of critiques have surfaced. While some of these critiques raise germane concerns — those of us who favor the policy raised them ourselves — others reflect a poor understanding of overtime rules, unrealistic predictions regarding employer reactions, and muddled logic. Below, we try to provide a more balanced set of expectations as to how the new rule might play out in the job market.
The new rule significantly increases the salary threshold below which most workers must be covered by overtime pay, from about $24,000 to about $50,000. Since the Fair Labor Standards Act of 1938, covered workers must be paid 1.5 times their hourly wage for time worked beyond 40 hours per week. We should also note that the updated threshold simply restores its inflation-adjusted value to its 1975 level.
One of the first critiques we heard is that employers will simply stop asking newly covered workers to work overtime (more than 40 hours per week). We agree and view this as a clear winner for these workers. What these critics fail to realize is that newly covered workers are not currently getting paid anything for overtime. Thus, under the new rule, this potential impact means that they would be working fewer unpaid hours. In other words, their implicit hourly wage — their salary divided by their weekly hours — would be higher under the new rule, and they’ll have more time outside of work. Obviously, this group of workers would be better off.
A second critique is that the new rule won’t help its intended beneficiaries because employers will just lower their base wage so that an employee’s total earnings — straight-time plus the now-required time-and-a-half pay — will be the same as it was before the rule change. We noted this response in our original analysis of the need to update the OT salary threshold, but we also pointed out a number of dynamics that critics have largely ignored, factors that lead us to expect such base-wage adjustments to be partial. To be clear, a partial adjustment means that newly covered workers who work overtime end up earning more under the new rule then they do today.
First, empirical research shows that it is very unusual for employers to lower the nominal pay of incumbent workers. The story critics are telling implies that the day the rule goes into effect, employers of affected workers will lower their pay, a scenario we are certain is highly unlikely. As time progresses, some employers may allow inflation to erode the base wage, and others may offer lower base pay to new workers who fall in the affected range. But once the salary threshold rises, we’re confident that millions of incumbent workers will be better off.
Next, we see no evidence in the literature suggesting a full adjustment to the point that newly covered workers would not end up with at least somewhat higher pay. In fact, earlier literature, as Bernstein discusses here, was explicit on this point (incomplete base-wage adjustment) and later work finds the adjustment to be less than half (meaning workers benefit from more than half of the benefits of overtime coverage).
It is worth noting that the literature on this base-wage-reduction impact is quite limited. Compared to say, the minimum wage, far less evidence exists regarding how employers will react to the higher salary threshold. We agree that some wage reductions will occur, but those who blithely assert that full adjustment will occur for all affected workers are more exposing their biases than reflecting what’s likely to happen based on prior experiences. Again, absent full adjustment newly covered workers would be better off.
Another point regarding hours worked, also noted in our earlier paper, is that a full negative adjustment of the base wage assumes that employers know precisely how many hours of overtime they will need from their workers (so they can reduce the base wage accordingly). Where there’s significant and unexpected variation in product demand, employers will be hard-pressed to make accurate base-wage adjustments. Of course, this means they could over-adjust by assuming more OT than will actually be needed. But that possibility raises another important issue that critics ignore: worker bargaining power. The full-adjustment model assumes workers lack the bargaining power to at least partially fend off such downward pressure on wage offers. This is a lot less likely to occur in tight labor markets, meaning there’s an important macroeconomic dimension to the incidence of new rules.
A related critique to those discussed so far strikes us as particularly incoherent: a) employers will fully adjust so no workers will benefit from the rule change, and b) the new rule will significantly increase labor costs and hurt businesses. Obviously, both critiques can’t be right.
Finally, some argue that employers will avoid OT for newly covered workers by hiring new straight-time workers (economist Dan Hamermesh, noted authority on OT rules, believes this will be a notable impact of the new rule: “I would argue it’s a job creation program”). Researchers at Goldman Sachs looked at this aspect of the response to a smaller increase in the salary threshold in 2004 and estimated that the new change could lead to the addition of 120,000 straight-time workers, though the researchers admit this may be an underestimate. An analysis by the National Retail Federation suggests that more than 100,000 jobs will be created in the retail sector alone.
GS researchers also find that the increase in wages will be small — about 0.1 percent — relative to the average wage in the total economy. But of course the new rule only affects a small subset of the overall economy, about 5 million workers, according to administration estimates. Concentrated among those workers, a back-of-the-envelope estimate suggests that the wage effect would be close to 3 percent (forthcoming analysis from the Economic Policy Institute finds that many more workers — more than twice the administration’s estimate — are likely to be covered by the new rule).
At the end of the day, what we have here is nothing more than the usual critics making the usual critiques. Many of those making the arguments we cite above raise similar objections to moderate increases in the minimum wage. These predictions have consistently been as cataclysmic as the ones for OT, and they’ve consistently been wrong. Obviously, we’ll have to carefully track outcomes, especially given the relatively thin literature on employers’ reactions to these sorts of changes. But our strong expectation is that by valuing workers’ time in ways consistent with a time-honored labor standard, affected workers will be better off.
Eisenbrey is vice president of the Economic Policy Institute.