How Will New Overtime Rules Affect You?

Thanks to the Fair Labor Standards Act of 1938 (FLSA), salaried workers are guaranteed overtime pay at time and a half for any hours they work beyond the standard 40-hour workweek, with exceptions to the rule based on both the duties involved and salary level. Exemptions exist for executives, professionals, administrative employees, outside consultants, and a few other classes of salaried employees — leading to occasional stretching of the definitions to avoid paying overtime pay.

The salary threshold has been far more contentious. The threshold value for overtime salary is currently $455 per week ($23,660 per year). In lower-paid retail jobs where the minimum wage is increasing, this can put employers in the perverse situation of having middle managers make considerably less per working hour than new hires. The threshold hasn't changed since a 2004 increase that raised it from $250 per week to $455.

Starting in December 2016, the salary threshold to avoid paying overtime will move to $913 per week (an annual salary of $47,476). The Department of Labor (DOL) originally proposed a threshold of $970 per week ($50,440 annually), but the new rule reached a compromise based on the 40th percentile of income for salaried full-time workers in the region of the US with the lowest wages (currently the South). Further inflation adjustments will be made every three years thereafter using the same 40th percentile criteria.

Doubling the salary threshold seems like an unusually large adjustment, but consider the effects of inflation. Using 1975 (when the threshold hit $250) as a baseline, the Economic Policy Institute calculated that full adjustment for inflation would result in a threshold of over $1000 per week (over $52,000 per year). Nearly 60% of workers qualified for overtime in 1975; in 2016, that number is only about 7%. A significant rise in the overtime qualification threshold is long overdue.

Businesses Cry Foul

Lower-wage businesses and service industries like hospitality and retail are understandably against the new rule. A press release from the National Retail Federation (NRF) declared the new overtime rules to be a "Career Killer." NRF contends that instead of increasing salaries to raise workers above the overtime threshold, many businesses will simply reclassify professionals as hourly workers, removing their existing perks, flexibility, and certain benefits (not to mention, we add, the potential loss of more prestigious titles). Comp time, where employees work overtime in exchange for future days off, is not allowed for those eligible for overtime under the new rules.

NRF-sponsored research from Oxford Economics concludes that the new rules will leave most workers without an increase in take-home pay due to limited hours or other pay adjustments to deal with the increases in payroll costs — for example, paying the necessary overtime but cutting base salaries to compensate. Administrative expenses such as the added costs of tracking hours for more employees and updating of payroll systems were estimated to cost businesses $745 million.

NRF appears on solid ground in questioning this one-size-fits-all approach. Wages and the cost of living vary dramatically around the country. An annual salary of $47,476 does not go nearly as far in urban areas like San Francisco as it does in rural areas of the South. Lower-wage retail jobs in rural areas will have a far harder time dealing with these rules. That's the reasoning behind the 40th percentile compromise, but NRF suggests that this does not go far enough.

In one way, businesses may be getting off easy. While the salary threshold has gone way up, the duties tests to qualify for exemptions has not changed. Had the DOL chosen to adjust these rules or define them more rigidly, employers would have a lot fewer alternatives in adjusting to the new salary threshold.

What Effect Will the New Rules Really Have?

It's no shock that businesses claim the rules will cause economic harm, but what about the other side of the argument? DOL contends that the new rule will set employers back $1.5 billion annually, with $1.2 billion in increased overtime pay and $300 million in corresponding administrative costs. That's a non-trivial amount, but a Wall Street Journal blog points out that in the context of America's nearly $8 trillion annual wages, the overall economic effect would be minimal.

DOL projects that 4.2 million workers will be directly affected by the change, and that another 8.9 million will be indirectly affected by reducing the ambiguity of their status. In other words, they should have been classified as non-exempt originally, based on their duties. In total, those affected in some fashion make up less than 9% of the workforce. To put that in perspective, the WSJ blog notes that a national $15 minimum wage would affect close to one-third of America's workforce.

Still, knowing the economy is not being harmed at the macro level doesn't help a small business decide how to institute the new rules on the micro scale. One business might decide that raising salaries above the threshold is better than tracking hours and paying overtime. Another might choose to limit workers to 40 hours and hire temporary staff or freelancers to make up the difference. Still others may prefer to pay the overtime, but cut base salaries or other benefits to compensate. Or any of them might simply reclassify workers, whether or not the reclassification is warranted. Put simply, each business owner will have to take into account the tradeoff of higher payroll and administrative costs versus a potentially dispirited staff that sees better opportunities elsewhere.

The DOL and NRF analyses do not address cumulative effects on small businesses. For example, businesses have already had to decide whether to deal with the extra costs of theAffordable Care Act or cut health benefits altogether and dump employees into the Healthcare exchanges. The overtime rules represent another cost that disproportionately affects small business and the cumulative effects could be too much for some businesses to tolerate — tying into the NRF's contentions.

The Takeaway

The new overtime regulations will likely cause hardships in some industries, and some employers may simply skirt the new regulations through reclassifications and adjusted hiring and salary practices. However, we agree with The Wall Street Journal that in the broad perspective, these new rules do not represent a massive drag on the economy. It's pretty hard to argue against revising an economic threshold that has only been adjusted once for inflation in over 40 years.

Moreover, these rules should benefit the lower end of the middle class — arguably, the group that has fallen the furthest behind as wealth inequity increases, because many social programs aim to help even lower incomes. What better place is there to inject some extra spending money into the economy?

Combined with the trend toward higher minimum wages, the second Obama term has overseen major steps toward narrowing economic inequality. Congress may attempt to redirect these changes with legislation, but it's more likely that the results of the November election will dictate whether that momentum is sustained.

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