Workplace Issues

A Middle-Class Mirage

The president wants businesses to pay more overtime, but unintended consequences could abound.
Economist StaffJuly 3, 2015
A Middle-Class Mirage

America’s workers have seen better days. Over the past decade private-sector wages have grown at an average yearly rate of just 0.3% after accounting for inflation — a fraction of their typical pace of growth. One response, embraced by Barack Obama this week, is to oblige firms to grant 5 million more workers “overtime pay” — 1.5 times their normal wage — for any period they work in excess of 40 hours a week.

Opinion_Bug7Hillary Clinton, the probable Democratic candidate for president, called it “a win for our economy and workers.” The economic evidence behind the policy, though, does not justify her enthusiasm.

The Fair Labor Standards Act (FLSA) of 1938 fixes a threshold salary above which workers are not entitled to overtime. The intention is to strip out managers and supervisors who, the argument goes, are harder to coerce into working unreasonable hours and are well compensated for their trouble anyway.

But the exemption has not kept pace with inflation. It is now $23,660 a year, below the poverty line for a family of four ($24,250). The proportion of full-time salaried workers eligible for overtime pay has fallen from 62% in 1975 to 8% today. Mr. Obama plans to increase the threshold to $50,440 a year by executive order, and to tie it to the 40th percentile of earnings, so that it gradually rises along with wages.

If businesses reacted passively to the new policy and followed it to the letter, it would make middle-class workers roughly $10 billion richer. Things will not work out so simply, however. Accidentally or deliberately, employers often fail to pay overtime. The Economic Policy Institute, a left-leaning think-tank, estimates that after accounting for other types of “wage theft” low-wage workers miss out on $50 billion each year. The Department of Labor has cooked up a down-on-his-luck cartoon character, Jason, to increase awareness of the rules. It wants people to tell it what “getting paid overtime [would] mean to you.”

Even if the new policy can be enforced, opponents say it risks altering hiring policies. If bosses know how many hours each week they intend to employ someone (including overtime), they may reduce the base wage they pay new recruits so that the total amount they end up forking out is just the same.

Cutting the nominal salaries of already-employed workers is tough, so some companies may simply stop them from working overtime to avoid the extra costs. Such firms may well stock up on new employees to fill the resulting gaps. But if the only effect of Mr. Obama’s plan is to create lots more low-paid jobs, he will presumably consider it a failure.