New overtime regs go into effect

A year ago I posted about proposed new federal regulations on overtime.  This week a revised version  went into effect.  Under the old regs, salaried workers earning over $23,660 had to be paid overtime each week they worked more than 40 hours.  Now the salary threshold has kicked up to $47,476, making 4.2m employees newly eligible.

The net effect will be to increase the cost of labor which will lead to reduced labor hours worked.  Hours worked per person will definitely fall, but employment may or may not change much.  Some employers will add more workers to avoid having to pay overtime, whereas others will substitute capital for workers.

The basic economics of the new overtime rules are very much like those of the minimum wage.  Some workers will come out ahead (those getting overtime that did not used to get it), whereas other workers are worse off because their hours get cut or their job vanishes.  Employers and their customers are worse off because costs have risen; after all, someone has to pay the higher overtime wages.  

Is it time for more overtime?

Last week President Obama announced new regulations that will expand the availability of overtime. Overtime is restricted to hourly employees, along with salaried employees who lack managerial responsibilities.  Defining the latter is dicy, so historically eligibility has been determined via a salary threshold.  Right now overtime is limited to those managers making less than $455/week.  The new regs kick that up to $970/week.

On the surface this would mean that about 5 million additional employees will now be eligible to collect overtime.  But we should expect employers and workers to make adjustments.  Under the old rules, exempt employees had an implicit understanding with their employer -- even though we do not get overtime, we are involved in a fair exchange where we provide so much work in so many hours and in return we receive so much income.

Employers looking to avoid the extra overtime charges have two options: cut hours so that they do not have to pay overtime rates or demand more work to be completed in the existing hours.  Assuming the overall workload stays the same, the first option will make sense for firms with low training costs and low spends on employee benefits (benefits are typically paid on a per person basis, rather than on a per hour basis).  Such firms can cut hours per person and hire more people.  The second option, which will usually involve downsizing, makes more sense when training new help is costly and benefits are expensive.

In deciding which course to take, employers have to make sure that they retain employees.  Whether they cut hours or increase workloads, employees will be worse off than before unless they start receiving some extra overtime pay.  Also, whatever deal is reached with the workers who are newly eligible will have to apply to those who were already eligible.  Bottom line: I expect to see adjustments along all three dimensions -- overtime hours worked (lower), workload expectations (higher), and overtime income received for newly eligible employees (higher).

How best to help low-wage workers

President Obama has made two proposals to help low-wage workers: an increase in the minimum wage and expansions in eligibility for overtime.  On the minimum wage front, he already has increased it for federal contractors and wants Congress to approve a $10.10 minimum wage for all.  Economists are fairly split on the merits of increasing the minimum wage; to get a good idea of how split see these two links from Greg Mankiw (hundreds are in favor, hundreds are opposed).

As for overtime, employers hire workers as long as the extra revenue they generate offsets the cost of the worker.  Employees with supervisory responsibilities are not eligible for overtime if they make more than $455 a week.  Obama has directed the Department of Labor to raise that threshold so that more become eligible for overtime.  Once again economists have a split opinion on the desirability of this policy.  A reasonable case can be made that this would have zero impact.  Employers could offset the increased overtime costs by slowing the growth of base pay and cutting employee benefits.  Those who lack the flexibility to cut pay and benefits will trim back on overtime hours and employment.  The federal government can set pay rules, but it cannot repeal the law of marginal cost equalling marginal revenue.

The Earned Income Tax Credit is another mechanism for helping low-wage workers, as Princeton economist Alan Blinder argues in this recent WSJ op-ed.  This policy receives nearly universal support from economists.  However it is not so popular in Washington because it forces the federal government to come up with the extra cash for low-wage workers instead of trying to stick employers with the bill.