Will new overtime rule help or harm?

A proposed rule to boost overtime pay is designed to catch up with changes in the labor market, but will it lead to unintended consequences?

From the pages of In Business magazine.

President Obama is sprinting to the finish line with a number of proposals to address the wage stagnation that has plagued American workers for 25 years, but in proposing to raise the threshold for overtime eligibility, is the administration doing more harm that good?

The president set the adjustment in motion in 2014 when he issued an executive order to update overtime pay that is eroded over time by inflation. Under the proposed rule, the salary threshold that determines who is eligible for overtime compensation would increase to $970 per week, or about $50,400 per year. That’s more than double the previous threshold of $455 per week, which has been in effect for a decade. The proposal would expand eligibility for overtime pay to an estimated five million more people.

There was swift and negative reaction from business interests. The U.S. Chamber of Commerce contends the rules will not increase worker’s income but instead limit employment opportunities, curtail growth in all other forms of compensation, and harm small businesses.

Restaurateurs worry about the higher threshold, because for the first time some of their managers would be eligible for overtime pay, while others believe the rules would force more people into part-time work. In its initial reaction, the National Restaurant Association acknowledged that supporters of the regulation want to increase Americans’ take-home pay, but countered that sweeping changes to the rules could mean anything but.

“More than 80% of restaurant owners and 97% of restaurant managers start their careers in non-managerial positions and move up with new, performance-based incentives,” notes Angelo Amador, the association’s regulatory counsel and senior vice president of labor and workforce policy, in a June 30 statement. “If these regulations stand, that mobility and adaptability of employee schedules, which makes our industry appealing, will be severely diminished.”

The National Retail Federation also says the proposal would limit career opportunities for workers, and it claimed the plan could cost retailers hundreds of millions of dollars in administrative costs, even if most workers see no increase in take-home pay.

Their reactions are nothing new, but are these business interests crying wolf? Labor economist Paul Osterman believes so. Osterman, a professor with the Sloan School of Management at the Massachusetts Institute of Technology, has seen such proposals come and go, and he concludes that many business worries are exaggerated.

“Every time the government changes its regulatory structure, whether it’s the Family and Medical Leave Act or whether it’s the minimum wage, a fraction of the employer community says the sky is going to fall, but somehow it never falls,” Osterman says. “So I would not be that concerned.”

While the new rule is still billed as a proposal, and it will likely take several more months to finalize, few observers doubt that it’s a fait accompli because it can be imposed without Congressional approval.

In this look at the likely impact of the proposed overtime rule, we spoke to Osterman and to Kurt Bauer, president and CEO of Wisconsin Manufacturers & Commerce. In a debate where few punches are pulled, Bauer says President Obama is living in a “parallel universe” if he thinks that constantly increasing the costs of doing business will lead to growth in private-sector jobs or wages.

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Overtime or over wrought?

For a variety of reasons, Osterman says wages for the average worker have stagnated over the past 25 years. Among the culprits is the fact that labor market regulations have not kept up with changes in the job market, so the administration’s new overtime rules are simply an attempt to play catch up.

According to Osterman, there is no historical data on exactly how employers will respond. It’s possible that a fraction of them will boost the pay of some managers so that it exceeds the higher threshold the administration wants to establish.

In his view, the more likely response is to roll with it. He notes that it’s cheaper for employers to pay time-and-a-half than it is to hire new people because there are substantial fixed costs associated with making new hires. Those fixed costs pertain to recruiting, training, and supervision, and he says they would exceed the cost of paying time-and-a-half to existing staff for overtime work.

“It’s costly to hire a person,” Osterman states. “The labor market’s economic jargon for it is fixed cost. You have to have to recruit, you have to train, and you have to supervise. The worries about it are exaggerated because employers will, in fact, still prefer to hire or to maintain one worker rather than incur those fixed costs.”

Bauer did not dispute the high cost of hiring, or an employer’s interest in reserving overtime for existing workers they know and value, but he maintains the new rule will make full-time employment more expensive for employers.

“When you look at it, the president, via executive fiat, punishes business for being employers rather than rewards them,” he says. “It drives up the costs, and businesses only have two responses. They can lower employment costs via layoffs or reduced hours and benefits, or they can raise the cost of their product or service, which makes them less competitive, especially in the global marketplace.”

Bauer also notes the law of unintended consequences, citing early evidence that dramatic minimum wage increases in San Francisco have driven up prices and caused some restaurants to go out of business. He also referenced newspaper accounts that Seattle’s new $15 minimum wage is causing some workers to toil fewer hours because if they earn too much money, they won’t qualify for the government benefits they have been receiving.

“That’s another one of those unforeseen, unintended consequences,” Bauer notes. “There is definitely a law of unintended consequences whenever you pass a piece of legislation or promulgate a rule. There’s always going to be something that you didn’t anticipate.”

Bauer doesn’t buy into what he calls the Keynesian “trickle-up” argument that increasing wages by government fiat leads to more demand for a company’s products and services. If wages go up across the board, he argues that cost-of-living expenses also go up, so the result is basically a wash. “All costs will rise at the same level, and while a person will find themselves with more money, they will be able to buy less with it,” he says. “Market demand for employees should determine wages, just like market demand for products and services should determine prices.”

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Classified information

There have been several proposals to address wage stagnation, including the new overtime rule and various measures to raise the minimum wage. The municipal government employers that have already raised it to $15 an hour have raised it well above the Obama administration’s proposed increase to $10.10 per hour.

Another idea that government officials could promulgate pertains to worker classification rules. Osterman notes that if an employee is classified by an employer as an independent contractor and not an actually employee of a business, the employer is not responsible for Social Security, pensions, and other benefits. Some employers in some industries have been increasingly creative about finding ways to misclassify people as independent contractors.

Although it has attempted to clarify how to interpret existing rules, Osterman notes the U.S. Department of Labor’s Wage and Hour Division, which administers the wage, hour, and child labor provisions of the Fair Labor Standards Act, and administers programs that cover government contracts, has not issued new rules defining employee classification.

One example of what employers do, he says, is require employees to incorporate as a one-person limited liability company, and then sign a services contract. “The government needs to modernize that,” Osterman says. “They have to find ways to make sure that people who are classified as independent contractors are genuinely independent contractors, and it’s not a subterfuge.”

In California, the state labor department recently issued a regulation regarding Uber Technologies, the San Francisco-based transportation network company. “They have a rule that Uber drivers are employees and not independent contractors,” Osterman says. “You also see a lot of this in the construction industry, which calls a lot of people who work on projects independent contractors when in fact they are employees. It’s a fairly widespread issue.”

Asked if he can understand where businesses are coming from, given that a number of wage-related proposals, plus higher-than-expected group insurance rates under the Affordable Care Act, are hitting them all at once, Osterman notes that employers naturally want to minimize their labor costs. He doesn’t offer that as a criticism, but he adds that an overemphasis on controlling labor costs is not always the smart way to operate a business.

“There is a lot of evidence that if you pay people well and train people well, your productivity and quality improves,” Osterman states, “but there’s always going to be that kind of cost-cutting instinct.”

Bauer doesn’t view the new overtime rule as apocalyptic or an example that the sky is falling, but he called it a troubling trend of government-mandated costs on business that he says are contributing to the weakest recovery from a major economic downturn since the Great Depression. Such proposals don’t necessarily ruin anyone’s business, he states, but they do force business owners to make adjustments that aren’t necessarily beneficial to existing employees, job seekers, or consumers.

Citing an American Enterprise Institute report that it now costs American businesses $1.8 trillion annually just to comply with government regulations, Bauer says the cost of doing business in the United States has gone up dramatically. “That is a staggering amount of money that is being diverted away from the productive economy into just complying with government regulations that are accelerating and expanding at a dizzying rate,” he states. “It’s very difficult for businesses to manage those increased costs, and all of them are government-driven costs. They are all because of government policies.”

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