Labor Department Issues Costly Overtime Rule

The Obama administration sees it as the middle class getting a raise. The details suggest it’s a demotion. On May 18, the Department of Labor published a final rule hiking the annual income ceiling for overtime pay eligibility of salaried employees from $23,660 to $47,476. Set to go into effect December 1, the regulation would benefit an estimated 4.2 million workers. However, it also may produce unintended consequences such as: loss of scheduling flexibility; pay cuts; benefit cuts; fewer work hours per week; higher employer compliance costs; and needless litigation. A group of lawmakers, led by Sen. Tim Scott, R-S.C., and Rep. Tim Walberg, R-Mich., have responded with bills to nullify the rule and make it difficult for the DOL to offer a substitute.

The mandate originated with an executive order from President Obama on March 13, 2014. Obama had directed the Labor Department, pursuant to the Fair Labor Standards Act, to draft a rule expanding overtime pay eligibility of salaried employees. The prevailing maximum threshold of $23,660 per year ($455 per week) would rise to $50,440 per year ($970 per week). Workers meeting the new standard would be converted to hourly status and receive “time-and-a-half” for work beyond 40 hours in a given week. The proposal was part of a broad administration effort to promote economic equality. The previous month Obama had signed an executive order raising the minimum wage for employees of federal contractors from $7.25 per hour to $10.10 per hour. And the proposed White House budget for Fiscal Year 2015 would expand the Earned Income Tax Credit by broadening eligibility and providing a larger credit for persons already eligible. The changes to the EITC would benefit a combined 13.5 million workers.

At the White House ceremony introducing the overtime rule, President Obama declared: “Overtime is a pretty simple idea.  If you have to work more, you should get paid more.” Not long earlier, during his State of the Union Address, he stated: “The cold, hard fact is that even in the midst of recovery too many Americans are working more than ever just to get by, let alone get ahead.  And too many still aren’t working at all.” Labor Secretary Thomas Perez emphasized the potential of unions in creating a sound economy. At the AFL-CIO convention in Los Angeles the previous September, he remarked: “Strong unions reduce inequality and build the middle class.” The AFL-CIO itself declared on its website: “It is time to update those (overtime salary threshold) levels and index them to prevent more and more workers from losing overtime protection every year.”

The Labor Department duly went about drafting a rule. And over a year later, on June 30, 2015, the department submitted a Notice of Proposed Rulemaking reflecting the contents of President Obama’s announcement. Nearly 300,000 public comments poured in, by any standard a staggering volume.  Finalizing the proposal would be no simple task. But it is now a reality.  On May 18, the DOL published a regulation raising the maximum salary threshold for overtime eligibility from $23,660 to $47,476 ($913 per week) – not quite the originally proposed level of $50,440, but high enough to benefit what the White House estimates will be 4.2 million workers. The rule would apply to businesses with at least $500,000 worth of annual sales. The $47,476 threshold will be upgraded every three years, based on the standard of the 40th percentile of full-time salaried workers in the lowest-income Census region. The rule also raises the “highly compensated employee” overtime threshold from the existing $100,000 to $134,004; above the latter figure, employers won’t have to show more than minimal proof of non-eligibility. As employers would need time to prepare for all this, the rule will take effect on December 1, 2016.

On the surface, the action seems overdue. Supporters frequently note that the income threshold for salaried employees had not been raised since 2004. White House economic adviser Betsey Stevenson said that if the income ceiling had kept pace with inflation, 3.1 million additional workers now would be covered. Last July, in a speech in La Crosse, Wisconsin, as the details were being worked out, President Obama remarked: “We’re making more workers eligible for the overtime that you’ve earned. And it’s one of the single most important steps we can take to help grow middle-class wages.” Capitol Hill progressives also had made their presence known in advance. In a February 29, 2016 letter to Secretary of Labor Thomas Perez, two dozen senators, including Democratic presidential candidate Bernie Sanders, called upon the Labor Department to put the overtime rule on the fast track. “As our economy continues to recover from the Great Recession, we, as a country, need to work on ways to help our economy grow from the middle out, not the top down,” the letter read. “But today, despite longer hours and higher productivity, workers’ wages have remained virtually unchanged. Millions of people are working harder than ever without basic overtime protections. We applaud the Department of Labor’s move to update the overtime pay threshold, and we are writing to request that you quickly finalize the rule to ensure millions of workers are paid fairly for the hours they work.” Organized labor likewise is on board.  On May 18, Service Employees International Union President Mary Kay Henry had this to say: “Working women and men should be paid for the time they work, period. The Obama administration’s decision to increase the overtime threshold is an enormous, in many cases life-changing, win for working people.”

These comments have a facile, interchangeable quality. As such, they invite skepticism. And skepticism should be directed not only at the size of the increase in eligibility, but at the very principle of a mandatory salary-to-wage conversion. In fact, back in April 2014, one month after President Obama’s executive order that got the ball rolling, NLPC criticized at length the rule change for its failure to address very likely negative consequences. The following is a recapitulation and update of that critique.

First, while forcing employers to reclassify salaried employees as wage-earners in order to make them eligible for overtime on paper will raise the workers’ pay, it won’t necessarily produce this result in practice. Employers have alternatives to avert this mandate. They can raise employee salaries currently close to the $47,476 threshold to something just above it, thus avoiding having to pay overtime. They can tell affected employees not to work more than 40 hours a week, and bring in part-time employees to pick up any slack. They can cut base pay for overtime-eligible employees; Bureau of Labor Statistics economist Anthony Barkume has estimated that employers could recoup about 80 percent of overtime costs by reducing wages. And they can reduce or eliminate certain benefits. Like it or not, such responses are perfectly legal.

Second, affected workers will have far less flexibility in scheduling work hours. It ought to be intuitive that employers who pay workers by the hour have more incentive to monitor clock time. The employers want to make sure they are not paying for hours not worked. Whether one considers flexibility to be a necessity or a perk, the rule change will reduce opportunities for professional employees and junior managers to run errands and deal with personal emergencies, especially if they involve minor children. Many employees suddenly will discover they won’t have the time to make trips to the bank, the post office, the car repair shop or the doctor’s office. Those employees seeking time off for such functions would need permission from supervisors. And if permission were granted, the result would be lost compensation. The rule also would discourage employees from working at home via computer and telecommuting. Daniel Yager, head of the HR Policy Association, which represents senior human resource executives of hundreds of major U.S. companies, takes this view. “The 100 percent increase in the salary level threshold for the FLSA’s (Fair Labor Standards Act) executive, administrative and professional exemptions is too much, too fast, and will only reduce the workplace flexibility employees want in today’s digital workplace and make it more difficult for them to manage their work/life balance,” Yager said on May 18. “Moreover, the final rule will likely result in restricted training opportunities and the inability for reclassified employees to participate in certain bonus programs without necessarily increasing take-home pay.”

Third, the rule change may delay career advancement for younger salaried employees. Being paid on the basis of a salary, as opposed to an hourly wage, connotes higher status. Employees, knowing this, may decline opportunities to work overtime, knowing that the extra money they make could be offset by the possible loss of opportunity is winning a job with greater responsibilities and higher compensation. From their standpoint, why jeopardize career mobility for short-term satisfaction? And that’s not even taking into account the fact that employers typically have the discretion to require employees to work overtime.

Fourth, compliance costs will be substantial. Employers would spend an estimated $3 billion and 2.5 million hours. These figures might well be underestimates. There are indirect costs to consider, especially if related to disputes between labor and management over the applicability of the overtime rule. The “primary duties” test is likely to become a good deal more subjective. And the DOL has spoken of eventually eliminating that test in favor of the “California test,” which stipulates that an employee who spends more than 50 percent of work time on non-exempt tasks is eligible for overtime pay, even if the salary exceeds the income threshold. In addition, the issue of who is an employee, as opposed to an independent contractor, will arise more frequently. Contractors are not employees. As such, they are not eligible for overtime pay.  Employers would have every incentive to reclassify employees as contractors; employees, by contrast, would have every incentive to resist such reclassification. And even with this area of conflict resolved, monitoring compliance with the rule will require extra hands on deck. The Department of Labor is likely to go on a (taxpayer-funded) hiring binge to expand Wage & Hour Division enforcement. As it is, the DOL has expanded its investigative force by about a third since 2010. The last time DOL revised Fair Labor Standards Act exemption rules, back in 2004, overtime lawsuits exploded. Employers, knowing they will be scrutinized more than ever, are likely to minimize their legal problems by spending large sums on staff or consultant studies to determine employee classifications. Employees reclassified as wage-earners, meanwhile, may deeply resent having to punch a time card. The likelihood of time theft under such circumstances is very real. According to HR Morning, a lot of employees may resort to such tactics as: taking care of personal business beyond scheduled breaks; coming in late but recording the arrival as “on time”; recording time falsely on behalf of another employee; and taking extended meal breaks.

Fifth, closely related to the previous point, the DOL rule may serve as a basis for more lawsuits. As it is, there is a multiplicity of “gray areas” in employee classification. And when definitions collide, litigation usually follows. The sharp rise in overtime-eligible employees virtually guarantees this. Richard Alfred, lead attorney for the wage and hour practice group at the Chicago-based Seyfarth Shaw LLP, described the rule to Fortune as creating “a perfect storm for new lawsuits.” Overtime lawsuits in the U.S. this year, he noted, will total about 9,000. That’s a roughly 10 percent increase over the 2015 figure of 8,160, which itself represented a doubling from 2005. “Once the new rules come out,” Alfred said, “companies will be under a lot more pressure to make these decisions about whether and how to reclassify people.” In Fiscal Year 2014, the Wage & Hour Division recovered about $241 million in back wages on behalf of aggrieved employees. The most common disputes have revolved around employee classification and its effect on overtime eligibility.  And mistakes can be costly for the employer.  An employee misclassified as ineligible for overtime can qualify for two years of back wages (three years, actually, if the misclassification was “willful”) at 1.5 times the hourly rate, plus liquidated damages equal to the unpaid wages. An employee effectively can collect triple his or her regular rate of pay. Employers will have every reason to hire top-flight auditors to insulate themselves from such consequences.

A number of Republican members of Congress, anticipating the future, are seeking to block it. This March 17, Sen. Tim Scott, R-S.C., and Rep. Tim Walberg, R-Mich., introduced the Protecting Workplace Advancement and Opportunity Act (S.2707, H.R. 4773) to nullify the overtime rule. The measure also would require the Labor Secretary to conduct a full analysis of the impact of any future overtime rule changes on small businesses, taking into account geographic cost-of-living differences. And on May 17, on the eve of publication, a coalition of nearly a dozen and a half free-market organizations, led by the Washington, D.C.-based Competitive Enterprise Institute, drafted a letter urging members of Congress to pass the bill. “A rule that could negatively affect millions of workers and the futures of numerous small businesses and industries,” the letter said, “cannot be issued without thorough analysis by the agency.” The signatories didn’t equivocate: “We encourage members of Congress to do everything in their power to nullify this rule and defund any future efforts to implement the final rule.” Under the Congressional Review Act, lawmakers have 60 days of continuous session to pass a joint resolution of disapproval.

Supporters of the modern welfare state operate on the assumption that the market generally works against achievement of moral justice. Yet their remedies often produce baneful consequences that are resistant to reversal or reform. The Labor Department’s overtime rule appears to be such a case. Nobody is arguing that people should be paid less than what they are worth. But the term “worth” is fraught with subjective judgments that very often are resolved only through litigation. No doubt the rule will create larger paychecks for many workers. But it also will create a lot of jobs for lawyers eager to bring forth avoidable and potentially costly lawsuits. And it will offset many of workers’ gains, while tethering workplaces more than ever to the whims of the federal bureaucracy. The Scott-Walberg proposal can serve as a check against these things.