The Agenda

The New Overtime Rule’s Effect on Wages and Employment Will Be Trivial, and Economists Know It

The Obama administration announced last week that it would raise the income threshold required to exempt white-collar employees from overtime rules, thus mandating that more workers receive time-and-half when they put in 40+ hours per week. The current income threshold is $455 per week (about $23,000 per year); we won’t know the new number until formal regulations are proposed and finalized.

Might the new regulation increase low-skill wages and create jobs, as former Obama-administration economist Jared Bernstein recently suggested in a New York Times blog post? It’s not likely. In fact, even Bernstein himself seems to have acknowledged the minimal effects of overtime regulation in his more formal work.

As policy changes go, I suspect this announcement is more symbolism than substance. To be affected by the rule change, workers must have incomes that fall between $455 a week and whatever the new threshold is. They must live in a state that does not already have its own higher threshold. They must have both the opportunity and the willingness to work overtime. And, finally, their employers must actually comply with the new overtime rule, which has been an obstacle in the past. So the announcement is probably a symbolic swipe at income inequality more than anything else.

But let’s assume that a large number of workers will be affected. How might businesses respond? The naïve view is that businesses will simply hand over higher overtime pay once it’s mandated, with no change to base wages or employment. But given that employees are currently willing to work for less than what will be mandated, businesses will inevitably try to reduce labor costs in some other way.

Anthony Barkume, an economist with the Bureau of Labor Statistics, analyzed the two leading theories about how employers respond to overtime-pay mandates. The “labor-demand” theory is that businesses will cut back on overtime and perhaps hire more employees to work straight-time. Current employees would not earn more money, but more people would have jobs.

By contrast, the “employment-contract” theory is that employers will simply reduce base pay to make up for the higher overtime wages. There would be no long-term changes in total wages or employment.

Barkume found much more empirical support for the employment-contract theory than for the labor-demand theory. All else equal, working more overtime is associated with a lower wage rate, and the lower base pay is enough to cancel out most of the legally mandated overtime wage premium. Since the employment-contract model seems to prevail, total wages and employment should be only minimally affected by the new overtime rule.

Curiously, Jared Bernstein also cited Barkume in a formal policy proposal, in which he seems to come to the same conclusion that overtime rules have negligible effects on total wages and employment. I’m genuinely confused about why he is still a strong supporter of the reform. In my view, it’s an administrative burden on business with no clear benefit to labor.


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