David R. Henderson  

Can Obama Really Raise Wages for Millions of People So Easily

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Quick answer: No.

Jared Bernstein, of the Center on Budget and Policy Priorities, writes:

By significantly increasing the salary threshold below which salaried workers get overtime pay, President Obama just took a big step toward updating a critical labor standard with the potential to boost the paychecks of millions of middle-wage workers, many of whom should be getting overtime but are not.

He explains:
The current threshold is only about $23,700. The president's proposal takes it up to $50,400, about $970 per week.

But the idea that a simple rule change can raise wages for millions of people is fantasy. Obama is acting as if he thinks that wages are just some arbitrary number that employers set. He really does seem to believe that if an employee is making, say, $40,000 a year and working 48 hours a week for, say, 50 weeks a year (the implied hourly rate would be $16.67), then an employer will respond by paying for 52 hours a week (8 hours of overtime times 1.5 for time and a half) at that same $16.67 for an annual pay of $43,333, a whopping 8.3 percent increase.

That's not how it works. The regulations don't magically make employees more productive. So what would employers do? One or more of three things. I list them in order of what I think is increasing probability.

1. If the employer were almost completely unimaginative, he would compare the the $43,333 in the above example with the employee's productivity. Those who couldn't produce something worth $43,333 plus the other benefits would be laid off.

2. Fortunately, though, for those otherwise laid-off employees, the employer has another option. Nothing has changed that would make the employer value the above employee's output more or want the employee to work fewer than 48 hours. There's a simple fix. Calculate that the number of hours that must be paid for per week, from the U.S. government's viewpoint, is 52 (40 plus 8 times 1.5). So cut the hourly wage from the implied $16.67 above to $40,000 divided by 52 divided by 50, or $15.38. There's some added paperwork hassle, but the employee makes the same amount.

3. A colleague with whom I was discussing this issue this week told me what his employer did many years ago when he was a young man in retail and his pay was under the threshold: have the employees clock in for 40 hours and work whatever number of hours the employer specifies. In other words, cheat. There is often a trust relationship between employers and employees. Most employees would have some understanding of the situation and would go along. The occasional employee would play the game and then go to the Labor Board of the state to complain. The Labor Board would force the employer to pay back wages but the employee would have more trouble than otherwise finding another job. The employer has to worry about this. But this solution would probably work most of the time.

By the way, there is someone I've very close to who just got a job a few thousand dollars under the threshold. I hope this person's employer chooses #2 or #3.


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CATEGORIES: Labor Market , Regulation




COMMENTS (20 to date)
Kevin Erdmann writes:

And progressives wonder why so many working class voters vote against them. I know progressives who consider this 50% overtime premium to be part of the sacred received moral rules we know to be true and they refer to the "cheating" as "wage theft". It then becomes a part of their evidence of how terrible corporations are. It's, frankly, the sort of can't-win tactic that is classic applied bigotry.

Even the employees who don't lose wages or hours from this will lose the valuable service of income smoothing that is a perk of being on salary - having a predictable weekly income for a job with unpredictable production.

I hope you don't mind the self-promotion, but I did an extensive post on this recently, with some additional data and some ranting about Bernstein's position and the false idea you point out regarding the supposedly arbitrary nature of compensation levels.

Andrew_FL writes:

Point 2. raises the question, I ask only half sarcastically, are salaries "sticky"?

Pajser writes:

David, it is interesting that you didn't considered the possibility that the capitalists will give up from part of their profit. It will certainly happen, to some degree - and that seems to be exactly the idea behind such political measures. And three things you mentioned will also happen, to some degree.

john hare writes:

I would like for pie charts to become popular showing the percentages the "greedy owners" take against employee costs. A 3-5% sliver of profit against 30-50% loaded labor cost, and 30-50% materials cost, and 10-30% capital equipment cost is highly visible on a chart. Caption reads, "So where does this 50% wage increase come from?"

For many people, the numbers we discuss are just words subject to discussion. A visual reference often makes the difference. With the chart, you can ask these people where to cut for more employee wages. If the profit sliver is taken, not only will it be insufficient to raise the wages that much, but the business is gone when owners have no reason to be there. Cutting materials screws the customer. Without capital equipment there is often no company. The obvious remaining source is to raise the prices to the customer.

Writing it in this comment is subject to argument. Having a visual representation of the facts is far less so. Too many people assume that (successful)owners make money off the percentage without having a comprehension that it is a large numbers concept. 3% of $10M annual sales is $300K in profit which is resented by the $15K employee. With a chart, it can be easily shown that the $15K employees in mass add up to ~$3.5M against the owners' $300K.

MG writes:

@Pajser,

I think Prof Henderson is aware that what you suggest may happen -- after all, that is THE INTENDED consequence of mandates like this. I suppose he is more worried that many of the UNINTENDED consequences have not been fully assimilated.

David writes:

What will happen in many companies, is that you won't be allowed to do official overtime, but still have to complete the same amount of work. So either work harder within working hours or do 'unofficial' overtime.

Dick White writes:

What continues to baffle me is why knowledgeable people like Jared Bernstein affirm scenarios like this one. He must know that the proposal won't work, yet he endorses it. I recognize that politician-rent seekers support these initiatives but I don't understand why well trained economists do.

Njnnja writes:

Along the lines of what David says above, the 4th consequence will be things like blocking the internet on office computers and keeping better track of lunch hours and errand running during the day. In general it will make work a less pleasant place to be as employers want to make sure that if an employee is on the clock for 11 hours that the employee is really doing 11 hours of work. Before, if you spent 11 hours "at work" but took an hour lunch and surfed the web for 30 minutes during the day, the employer didn't care. But now they will resist paying that employee for 11 hours when they only worked 9.5.

James Hanley writes:

A fourth approach is to get the same amount of work--regular + overtime--out of employees, but compressed into only regular hours. My wife, an administrative assistant at a college working for several academic departments, is under that threshold. Once upon a time when the college administration needed extra help (graduation and other events that required extra staffing) they asked for volunteers and paid for the extra time. Now they draft administrative assistants to help out and require them to take comp time instead of getting paid extra. This doesn't reduce the work they have to do for the academic departments, but does reduce the amount of time they have to get it done.

It's effective for the administration because they save money and the non-monetary costs are pushed out of the Admin building onto the academic departments.

As I tell my students, when designing policies, don't get blinded by the goal you want to achieve, but keep your focus on the incentives you're actually creating.

mike davis writes:

David seems to suggest the new overtime rules might not be so destructive since employers can cut the hourly rate to keep the total compensation under the mandatory overtime rule equivalent to what it was before the rule change (solution #2) . That’s correct, but only if there is no uncertainty in the number of hours an employee would need to work. In the real world, though, staffing needs are stochastic (another employee might call in sick, business is surprisingly good, etc). In practice the rule will increase the volatility both in what the employer pays and what the employee earns. Walmart may not care—they’re more or less risk neutral. But small businesses and middle income workers may care a lot.

In many labor markets a job seeker who can tolerate a flexible schedule has an advantage. Under these rules a job seeker who can tolerate a flexible income will have an advantage. I don’t see how that’s a good thing.

One other complication: the new rules raise the marginal cost of employing a worker for extra hours. Again, that may change the pattern of employment in unpredictable and unfortunate ways. (Walmart, for example, might decide that instead of asking a good assistant manager to work extra during the holidays, it will ask less competent part-timers to muddle through.)

Jay writes:

@Pajser

Ah yes the miraculous "bucket of profits" out of which all dreams may come for the working class free of charge. This is usually the last resort since firms don't operate for long with excess profits and typically the employer needs to answer to investors who wouldn't appreciate a chunk of the existing profits being taken out when there are less-costly alternatives.

Lee Waaks writes:

Pajser wrote: David, it is interesting that you didn't considered the possibility that the capitalists will give up from part of their profit. It will certainly happen, to some degree - and that seems to be exactly the idea behind such political measures.

Profits are mostly invested so we should also consider the long-term consequences of capital consumption.

David R. Henderson writes:

@mike davis,
Good point. I was too brief. It’s precisely your kind of thinking that led me to #3. I should have made that clear.

ThomasH writes:

Another alternative:

4. Firms could lobby for an increase in the EITC that would raise workers incomes without costing firms anything.

David R. Henderson writes:

@Pajser,
David, it is interesting that you didn't considered the possibility that the capitalists will give up from part of their profit. It will certainly happen, to some degree - and that seems to be exactly the idea behind such political measures. And three things you mentioned will also happen, to some degree.
I didn’t consider it for two reasons: (1) I think it’s obvious that restrictions on contracts with employers will hurt employers and, thus, hurt profits, and (2) my focus, as I said in my post, is on how employers will respond. The whole reason to respond is precisely because of the hit on their profits.

Andrew_FL writes:

@ThomasH- Are you under the impression "E"ITC is a free lunch??

If it doesn't cost firms anything, who does it cost to increase workers income???

Hazel Meade writes:

Here is what will obviously happen:

The employer will cut pay raises for employees for a few years until salaries adjust such that the total pay, including the overtime, come within the original salary budget. Employees that work more overtime will get larger raises. Employees that work less overtime will get smaller raises. But in general raises will be smaller until the base salary adjusts.

Net effect, basically nil, except that employees who work more overtime will get their extra pay in real time instead of waiting for an annual raise.

Hazel Meade writes:

[Comment removed for rudeness. Email the webmaster@econlib.org to request restoring your comment privileges. A valid email address is required to post comments on EconLog and EconTalk.--Econlib Ed.]

Hasdrubal writes:

Option 3, working under the table overtime, is not going to be very common.

Every company (larger than about 20 employees) that I've worked for in the past 10 or so years has made working overtime without claiming it a firing offense. The penalties for getting caught not paying overtime (fines, legal fees, PUBLICITY) far outweigh the benefits. And you can bet your shorts that regulators will be waiting in the wings for overtime violations in the wake of a change in policy.

I think Hazel Meade is correct in that employers will freeze/reduce pay increases until compensation is back on track.

I think there will also be a lot of people being forced to do 48 hours worth of work in 40 hours, with no overtime authorized and with the threat of being fired if they do work late.

I think Njnnja is also right, employers will add more hassles to employees lives in an attempt to make them more productive.

I think starting salaries will fall to compensate: Wages for current employees might be sticky, but wages for new employees aren't.

I think a lot of employees won't be financially affected by this since they don't work overtime, but they will lose flexibility in their working schedule because they got reclassified to hourly. (I used to love working holidays when I was single and salaried: No family for 500 miles, so I wasn't going to do anything for Thanksgiving anyway. But a flex day that I could take at my leisure was great. Then I got moved to hourly in one of these redefinitions, and flex days disappeared.)

A lot of things will happen, few will be beneficial to employees.

Mark V Anderson writes:

Yes, Hazel has it right. Wages are indeed sticky, so cutting salaries are usually not a viable option if you want good employees. But over the course of a few years, it will all even out. Much like minimum wages, but this is even easier for companies to finesse, since the wage rates themselves can be eased down.

Probably some economist will do a study on this a year after the change and proclaim that Obama was right after all, because few had their wages cut.

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