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Tuesday, October 26, 2004

The Overtime Rules--They Haven't Gone Away

I wrote this in August, before I started this, and, since the proposed overtime rules are still around, I wanted to post it here:

The Department of Labor put in place new rules governing eligibility for overtime pay on August 23, 2004. In implementing these rules, the Secretary of Labor, Elaine Chao, emphasized that some additional workers would receive overtime coverage as a result of increasing the threshold below which overtime pay is required. The Economic Policy Institute, among other independent research organizations, focused on changes in the rules that will make it easier for employers to classify workers’ duties in ways that will make them ineligible for overtime pay.

What has so far gone without comment is the ways in which the new rules change the incentives for workers and for employers.

Workers will now have an incentive to want to work fewer hours per week.

Employers will now have greater incentives to increase the length of the work week, and to employ fewer workers.

Reduced Work Incentives

One of the overlooked aspects of overtime pay is that it provides an incentive for workers to want to work additional hours. What we have learned about the decisions workers make about their preferred weekly hours tells us that it pay for the additional hours has a significant effect on the length of the desired work week.

Put simply, if workers receive higher pay for additional hours than for the basic work week, they will be more willing to work additional hours. This premium pay helps compensate them for the real additional costs of spending more time at work, and less time with their families or in leisure activities. Overtime pay does just that.

Removing the overtime premium will have exactly the opposite effect. Consider a group of workers currently earning straight-time pay of $15 per hour, and working, in a typical week, 45 hours per week. The current overtime rules make additional hours worth $22.50 per hour. Under the new overtime rules, if their employers reclassify their work so that these workers lose their overtime eligibility, their pay for additional hours will be zero. Furthermore, with overtime eligibility, a worker choosing to work a little less would lose $22.50 for each hour not worked. That same worker, reclassified as ineligible for overtime pay, faces a cost of zero for working less.
Clearly, workers who are reclassified will now want shorter work weeks.

Fewer Jobs

When Congress enacted the Fair Labor Standards Act in the 1930s, one objective was to increase the cost to firms of using workers for long hours, and to provide employers with a greater incentive to hire additional workers (by reducing the length of the work week).

Employers have always had reasons for preferring extending the work week to expanding employment. There are fixed costs of hiring additional workers. These additional workers must be recruited, screened, and trained. These hiring costs are about the same whether someone works 30 or 50 hours per week. In addition, some benefits, such as employer-paid health insurance, are also per-worker, rather than per-hour, costs. An overtime premium raises the costs of additional weekly hours, and at least encourages employers to consider expanding employment rather than extending the work week.

Now, consider what happens when we remove the overtime premium, by making it easier for employers to reclassify workers, making them ineligible for overtime pay. In booms, the incentive employers have to extend the work week will be greater. In recessions, the incentive employers have to lay workers off, rather than reduce the length of the work week, will be greater. In normal times, the incentive employers have to extend the normal work week and reduce employment will be strengthened.

In booms, employers’ demand for labor will increase. If employers have reclassified workers, making them exempt from overtime pay, they will now find that the costs of extending the work week, relative to the costs of hiring new workers, will be lower than it was under the old rules. Indeed, the ease of reclassification into salaried jobs, rather than hourly jobs, adds even more to this outcome. So, in booms, extending the work week becomes, under the new rules, an even more cost-effective way of increasing use of labor. So there will be fewer jobs in booms.

In recessions, employers must chose between reducing the work week (work-sharing) and layoffs. If a firm’s employees, before the recession, are receiving overtime pay because of regularly-scheduled overtime, then reducing the work week can lead to relatively large savings. For employers, however, who have reclassified workers, the cost savings of reducing the work week are essentially zero. Their incentive is even stronger than it would have been to use layoffs to adjust to the recession. So there will be fewer jobs in recessions.

In “normal times,” the new rules will have a similar effect. By making it easier to reclassify workers, making them exempt from overtime pay, the new rules will reduce the costs of extending the work week, even if workers do not normally receive overtime. Workers who were formerly paid on an hourly basis at least received additional pay for any additional hours if the work week were to be extended. Once reclassified, they will not. The cost to the employer of extending the work week falls. At least some employers will now give additional consideration to reclassifying workers, extending the work week, and reducing the number of people they employ. So there will be fewer jobs in “normal times.”


There may be some debate about that will happen to the number of workers eligible for overtime pay under the new overtime rules. But no one who is familiar both with the economic theory and with the facts about how workers and employers make decisions would argue anything other than that these three propositions are true:

(1) Workers will want to work shorter work weeks.

(2) Employers will want to extend the work week and hire fewer workers.

(3) And tensions in the work place will increase.


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