* On Monday, the Labor Department's new overtime rules took effect. The Department claims that the new rules will lead to a net 1.2 million rise in the number of workers eligible for overtime pay. Meanwhile, the Economic Policy Institute (EPI), a left-of-center think tank, estimates that a net 6 million workers could lose their overtime rights. Unfortunately, it is difficult to assess conclusively who is correct.
* Fortunately, however, we can say with some confidence that the new rules are unlikely to have a meaningful macroeconomic impact. Not only are the dollar numbers small in relation to total personal income, but the competitive US labor market ultimately limits the potential impact of administrative regulations on overall wage levels.
The New Overtime Rules: Little Macro Impact
American employees who work over 40 hours per week are typically paid a premium of 50% over their regular wage on overtime ('time- and-a-half'), provided they meet the overtime eligibility requirements. The overtime rules were first laid down in the Fair Labor Standards Act of 1938 (FLSA), in the aftermath of the Great Depression. Historically, a large majority of wage and salary workers -- a group that currently numbers 131 million -- have been eligible for overtime pay.
On Monday, the Labor Department enacted new and controversial eligibility rules. The new rules have become an important issue in the presidential election campaign. The Labor Department claims that the new rules will lead to a net 1.2 million rise in the number of workers that are eligible for overtime. Meanwhile, the Economic Policy Institute (EPI), a left-of-center think tank, estimates that a net 6 million workers could lose their overtime rights. Senator Kerry campaign has called the new rules 'a shameful assault on the paychecks of hard-working Americans.'
The issue is quite complicated, and the briefing papers issued by both sides are accordingly long. (The Labor Department report is at <http://www.dol.gov/esa/regs/compliance/whd/fairpay/econreport.pdf>, and the EPI report is at <http://www.epinet.org/content.cfm/briefingpapers_bp152>. Broadly speaking, workers are eligible for overtime pay unless their pay is above a certain threshold, they are not paid by the hour, and their work involves managerial, administrative, or professional skills. All three requirements must be met in order to exempt a worker from overtime protection.
There are three main changes in the new rules. First, the salary threshold below which employees are guaranteed overtime pay increases to $455 a week from $155 a week. This will unambiguously raise the number of workers eligible for overtime. The Labor Department estimates this number as 1.3 million, the Economic Policy Institute as 400,000.
Second, a new rule exempts some highly-paid employees with annual incomes of $100,000 or more who previously were non-exempt. This will unambiguously strip some workers of overtime rights. The Labor Department estimates this number as 107,000, the Economic Policy Institute as 400,000.
Third, the definition of what constitutes managerial, administrative, or professional skills changes in a number of often quite subtle ways. Most of the controversy surrounds this last issue. The Labor Department argues that the new rules are at least as stringent as the old ones, while the EPI sees them as much looser and therefore much more apt to deny overtime rights to workers.
Unfortunately, it is difficult to assess conclusively who is right. This is because the devil is in the details, and much depends on how the courts will interpret the new rules. For example, a report for the AFL-CIO -- the head organization of US labor unions - written by three former Labor Department officials in the George H.W. Bush and Clinton Administrations says that 'the new rule could conceivably extend exempt status to as many as 53 million more workers' but then goes on to note that 'it is impossible to predict' how many workers will be affected in practice.
Fortunately, however, we can say with some confidence that the macroeconomic impact is likely to be small, at least if we limit our analysis to the range of potential eligibility changes indicated by the Labor Department and EPI studies.
First, the official estimates imply only a tiny wage impact. The Labor Department estimates that the net increase in overtime eligibility will raise wage and salary payments by $375 million per year. This is less than 0.005% of total personal income -- a tiny number if there ever was one.
Second, although the EPI does not provide any dollar estimates, our back-of-the-envelope calculation suggests only a small hit, even under some rather aggressive assumptions. EPI estimates that a net 6 million workers will lose overtime eligibility, which equates to about 5% of payroll employment. Moreover, data from the payroll employment statistics suggest that overtime hours account for about 10% of total weekly hours for eligible employees. (These data refer to the manufacturing sector; comparable numbers for other industries are not available.) Assuming that a loss of overtime eligibility is tantamount to an immediate loss of overtime pay -- a very aggressive assumption that almost certainly leads to an overstatement of the total effect -- this implies that 5% of the workforce would lose about 5% of their pay. (The latter 5% number is calculated as the product of a 50% overtime premium multiplied by the 10% share of overtime in total hours.) This would imply a 0.25% hit to total wage and salary income and about a 0.15% hit to total personal income. These negative numbers are more than an order of magnitude larger than the positive ones calculated by the Labor Department, but they still are quite small. In addition, such changes would probably take place gradually, so they would be difficult to detect in monthly or quarterly data.
Third, basic economic logic argues against a large impact of new overtime regulation on worker incomes. This is because the US labor market is competitive. On the one hand, most firms are free to lay off workers whose pay is increased sharply as a result of any increase in overtime eligibility, or to renegotiate their basic pay levels. On the other hand, workers can leave for greener pastures if they are unhappy with their pay, and they frequently do so even in a soft labor market. This implies that any sharp drop in overtime pay -- as estimated by the EPI -- would likely lead to an increase in the number of workers leaving their jobs and looking for work elsewhere.
Jan Hatzius