The Department of Labor’s Method for Automatically Updating the Salary Level for Overtime Exemptions will Cause Increases That Exceed Growth in Wages and Salaries
INTRODUCTION
In the Final Rule “Defining and Delimiting the Exemptions for Executive, Administrative, Professional, Outside Sales, and Computer Employees” (Rule), the Department of Labor (DOL) dismisses concerns that the proposed mechanism for automatically updating the standard salary level will result in increases to the salary level above and beyond those related to wage growth. Importantly, our analysis finds that, even if there is no wage inflation, the DOL’s methodology would likely result in a 9.1% increase in the salary level over the next three years if employees assumed to be impacted by the NPRM are reclassified as hourly.
As described in a prior article[1], the large increase is a result of the DOL’s updating mechanism, which sets the salary level at the 35th percentile of the pay distribution of non-hourly workers in the South every three years. If the affected employees are reclassified to hourly, they will no longer be in the non-hourly pay distribution used to update the salary level in three years, resulting in a large increase in the 35th percentile of that distribution.
In response to comments to the proposed rule and our earlier analyses, the DOL claims that most affected employees will become salaried non-exempt, so that the share of affected employees that will be reclassified to hourly will be small. Their justification for that assumption is twofold: (1) most of the affected employees don’t work over 40 hours per week and (2) studies of previous changes to the salary level have not resulted in a large shift of salaried employees to hourly pay. This article explains why the DOL’s arguments are insufficient to dismiss concerns about the automatic update mechanism.
WEEKLY WORK HOURS OF AFFECTED EMPLOYEES
In the section of the Rule called “Workers May Remain Salaried Even if Nonexempt,”[2] the DOL asserts that “for the majority of affected employees, there will be no incentive for employers to convert them to hourly pay because they do not work more than 40 hours in a workweek.” This claim is based on an unreported DOL analysis that combines data from two surveys, the Current Population Survey (CPS) and the Survey of Income and Program Participation (SIPP). As explained below, this analysis is unreliable for assessing employers’ incentives for converting affected employees to hourly pay.[3]
Unreliable survey data on usual weekly work hours
The CPS and SIPP surveys ask respondents to report their usual weekly work hours. Responses to this question cannot provide a reliable measure of the number of salaried employees who usually work 40 hours per week but occasionally work more than 40 hours in a week.[4] Survey responses about usual hours worked per week from workers who are currently exempt from the FLSA, and who presumably do not punch a time clock, should be viewed as an approximation of typical weekly work hours.[5] The only other work hours question asked in the CPS is about hours worked in a specific “survey week,” which is also not a reliable information source for whether workers affected by the Rule may occasionally work more than 40 hours in a week.
The DOL states that it supplements information from the CPS with information from the 2021 SIPP survey to attempt to estimate the number of affected employees who ever work more than 40 hours in a week. The SIPP survey is conducted annually and asks respondents to provide information about their usual work hours per week in jobs held in the previous calendar year, but it does not ask respondents if they ever worked more than 40 hours in a week in those jobs. SIPP Respondents are asked to provide the number of hours “usually (more than half the time) worked per week at their job” and allows them to provide up to two changes in usual hours per week during the previous year. If Respondents indicate that their hours vary, they are instructed to attempt to give an average amount.[6] None of these responses can be used to reliably determine the fraction of respondents who ever worked more than 40 hours in a week in their job.[7]
Neither the CPS nor the SIPP surveys provide reliable information about the number of salaried employees who occasionally work more than 40 hours per week. Nonetheless, the DOL incorrectly concludes that most currently exempt workers who will be affected by the Rule do not work more than 40 hours per week, and their employers have “no incentive” to convert them to hourly employees.[8]
Non-exempt status requires employers to track weekly work hours
Even if the DOL is correct that most employees affected by the Rule never work over 40 hours per week (and their employers know that), they ignore the critical point that non-exempt status means employers are required by law to track weekly work hours so that any instances of overtime are identified and properly paid. Employers have an incentive to convert affected employees (salaried employees who pass the duties test but are nonexempt because of the Rule) to hourly employees even if they occasionally work more than 40 hours to facilitate accurate overtime premium payments. Even if these affected employees continue to be paid on a salary basis, they will have to record their work hours and be paid overtime if they ever exceed 40 hours in a week. This makes it very likely that they will answer the CPS survey question of whether they are paid hourly in the affirmative. That alone would result in their removal from the non-hourly pay distribution on which the DOL’s automatic updating mechanism is based.
The need to track work hours, accurately measure regular rates of pay per hour, and pay overtime premiums on all work hours over 40 in a week also means it will be more cost-effective for many employers to reclassify these employees to hourly status. Because many businesses already employ both salaried and hourly employees, and given the mandate to begin paying overtime premiums to some additional employees on July 1, 2024 (and even more additional employees beginning in 2025), it will likely be easier to convert salaried employees affected by the rule to hourly status instead of developing a new time and pay system to support overtime premium payments for employees in salaried non-exempt positions.
Hourly or salaried pay decisions are not individualized assessments
The DOL also mistakenly views an employer’s decision of whether to pay a worker a salary or by the hour as a decision made employee-by-employee, rather than for a group of employees in the same position. Firms typically respond to overtime pay requirements by treating employees in the same position in the same way with respect to their hourly/salary status. The DOL’s argument implicitly assumes that employees in the same position within the same firm will be treated differently with respect to hourly/salary status based on their individual weekly work hours without any data to support this dubious assumption.
For example, the DOL expects more than 90% of the thousands of Financial Managers who earn salaries between the current and new salary level would pass the duties test.[9] No survey of individual Financial Managers, whether CPS or SIPP, can provide reliable information about the percentage of businesses that have an incentive to convert salaried Financial Managers to hourly employees. Businesses will assess the hourly/salary status of Financial Managers, and other job titles, as a group.[10] Hours worked reported by an individual survey respondent is an approximation, may differ among co-workers in the same business, and may differ from one year to the next. Businesses will not make decisions based on individual employee experiences in a particular year. The DOL is incorrect to assume that Financial Managers who are affected by the Rule but report 40 usual work hours of work per week will not be converted to hourly. Salaried employees who report usually working 40 hours may be reclassified to hourly status because co-workers in the same position regularly work more than 40 hours per week, and hours worked may increase as the demand for their services expands.
STUDIES OF PREVIOUS SALARY LEVEL CHANGES
The DOL claims they “found no evidence that previous changes in the salary level for exemption have resulted in a statistically significant increase in the percent of full-time white-collar workers paid on an hourly basis.”[11] However, the Rule’s increase in the salary level for exemption is much greater and affects many more white-collar employees in different jobs with different duties than the workers affected by the salary level increases in the studies cited by the DOL. Consequently, evidence from earlier studies about the effects of salary level changes cannot simply be extrapolated to predict the outcomes of the Rule.
Lack of Relevant Data
Before getting into the details of the empirical studies cited by the DOL, it is worth nothing that there is no survey by the DOL, the BLS, or the Census Bureau that estimates or measures the number of nonexempt employees in the U.S., regardless of whether they are paid by the hour or earn a salary. As such, empirical studies examining the impact of changes to the salary level for the white-collar exemption will be limited in what changes they can identify.
The DOL assumes that most workers affected by the Rule will become salaried nonexempt instead of being reclassified as hourly employees. This assumption is not innocuous and is, in fact, necessary for the DOL to claim that the automatic updating mechanism will not cause the salary level to increase by more than wage inflation. Despite the importance of the assumption that millions of workers will be classified as salaried nonexempt, for the expected magnitude of future salary level increases, it is notable that the DOL does not provide any estimates of the number of employees currently classified as salaried nonexempt. The DOL also does not present any empirical evidence about changes in the number of salaried nonexempt employees over time.
Comparisons to 2004 Federal Increase
Many of the studies that the Rule references were also mentioned in the 2016 Final Rule for the white-collar salary level. These studies include an internal DOL analysis of the change in the FLSA salary level in 2004. The increase in the salary level to the 20th percentile of the non-hourly pay distribution in the South in 2004 had a very different effect on employers’ incentives to reclassify salaried workers as hourly employees than one should expect from the current Rule. First, as explained below, the jobs and duties of white-collar employees earning below a salary level equal to the 20th percentile of the pay distribution are substantially different than the jobs and duties of employees paid less than a salary level equal to the 35th percentile. Second, the 2004 salary level was the first increase in almost three decades and there was no reason for employers to expect another salary level increase within three years. In contrast, the Rule mandates increases in the salary level every three years.
In the Rule, the DOL states that more highly paid white-collar employees are more likely to pass the duties test and qualify for the white-collar exemption.[12] The positive correlation between pay and the performance of white-collar duties means that the jobs and duties of affected workers in 2024, who earn between the 20th and 35th percentiles of the pay distribution, are substantially different than the jobs and duties of workers who earned less than the 20th percentile of the pay distribution in 2004.
The DOL estimated in the 2004 Final Rule that 1.3 million exempt white-collar employees who would pass the duties test would fail the new salary level test.[13] Similarly, in the 2019 Final Rule which raised the standard salary level test to $684 per week effective January 1, 2020, the DOL estimated that 1.1 million exempt white-collar employees would be affected.[14] The DOL now estimates that 4 million exempt white-collar employees who would pass the duties test will fail the new salary test within the first year due to the current Rule, even before potentially large adjustments are made in future years. The DOL’s current Rule, because of its much higher salary level, will cause more than three times as many white-collar employees to not be considered bona fide executive, administrative, or professional workers only because of their salary level, compared to the 2004 Rule.[15]
Comparisons to California Rule Change
The other noteworthy internal DOL study cited in the Rule examined changes in the salary level for overtime exemptions in California. This study is also of limited value in projecting the consequences of the Rule. The number of workers who are re-classified from salaried to hourly due to a higher salary level is expected to be quite different in California than in the South region.[16] In California, white-collar employees face a different duties test, daily overtime is required when work hours exceed eight in a day, and there are meal break requirements for nonexempt employees. In addition, the salary level for the overtime exemption is twice the minimum wage multiplied by 40 hours per week in California. This means that, year after year, the California salary level will increase in lock step with scheduled increases in the California minimum wage. The responses of employers in California to small and persistent increases in the California salary level are not particularly relevant or informative for projecting the response of Southern businesses to the 65% increase in the FLSA salary level on January 1, 2025 and the automatic salary level updates mandated by the Rule.[17]
POSSIBILITY FOR MORE AFFECTED WORKERS
This article and our prior analysis focused on employees who the DOL refers to as “affected by the Rule.” These include only non-hourly workers earning between the existing and new salary level who are expected to pass the duties test. However, there are 1.7 million white-collar workers in the South region who are not paid by the hour and earn between $684 and $1128 that the DOL assumes would not pass the duties test. The DOL’s estimate of the number of employees affected by the Rule may be substantially understated if some of these white-collar employees are paid a salary because their employers, who understand their duties and responsibilities, believe they would pass the duties test. If this is true, some of the1.7 million white-collar workers who the DOL assumes are unaffected by the Rule will also be affected and could be converted to hourly status. As these employees leave the lower end of the non-hourly pay distribution, it will accelerate the increases in the salary level adjustment process every three years.
CONCLUSION
The Rule increases the salary level from $684 to $1128 per week and will cause some employers to convert some salaried workers earning less than $1128 per week to hourly status even though they would have passed the duties test. These re-classifications of workers from salaried to hourly status, in conjunction with the method for automatically updating the salary level, will cause future automatic salary level increases to exceed the average growth in wages and salaries. Automatic salary level increases that exceed average wage growth will cause even more white-collar employees to be converted from salaried to hourly status.[18] With each automatic update the duties test will become irrelevant for an increasing share of employees in white-collar jobs. Over time the salary level test will become relatively more important, and the duties test will become relatively less important for determining which white-collar employees are exempt from the FLSA.
CITATIONS
[1] “Important Implications of the DOL’s Proposed Automatic Updating Mechanism”, October 26, 2023. https://www.edgewortheconomics.com/publication-6501
[2] Rule, p. 32937.
[3] The CPS is the data set used by the DOL to estimate the 35th percentile of the non-hourly pay distribution and the number of workers affected by the Rule.
[4] For example, in neither survey are respondents asked whether they have ever worked more than 40 hours per week in their current job.
[5] CPS respondents also report hours worked in the survey week. Hours of work responses appear to be approximations because most respondents report hours worked to the nearest five hours per week. Among full-time white-collar non-hourly workers not in named occupations earning between $684 and $1,128 in the 2023 CPS, 2.6%, 81.5%, 3.4%, and 4.9% reported usually working 35 hours, 40 hours, 45 hours, and 50 hours per week respectively. Only 0.7% reported usually working 41-44 hours per week and 0.6% working 46-49 hours per week. There are similar patterns in SIPP responses; about 80% of respondents indicate they usually work either 35, 40, 45 or 50 hours per week.
[6] 2021 SIPP User’s Guide. https://www2.census.gov/programs-surveys/sipp/tech-documentation/methodology/2021_SIPP_Users_Guide_SEP23.pdf
[7] SIPP respondents who consistently work 40 hours in three of every four weeks but work an additional eight hours in one of four weeks would accurately respond that usual work hours are 40 per week but would provide no information about the frequency of potential overtime work. SIPP respondents with variable work hours per week, but with an approximate average of 40 hours per week, would accurately respond that usual work hours are 40 per week, but would not indicate how often their variable hours exceeded 40 per week.
[8] The DOL concludes that 69% of affected employees never work more than 40 hours in a week.
[9] In 2023 CPS data, 55% of Financial Managers with weekly earnings between $684 and $1,128 reported they are paid hourly. The likelihood that workers pass the duties test, according to the DOL, is approximated from a 1999 GAO study.
[10] Based on 2023 CPS responses, about 7% of non-hourly Financial Managers earning between the current salary level and proposed 35th percentile salary level reported either usually working more than 40 hours per week or working more than 40 hours during the survey week, while the corresponding percentage in 2022 was 19%. These responses provide no reliable information about the likelihood that the hours worked by any Financial Manager ever exceeds 40 in a week, in businesses that pay some Financial Managers between $684 and $1128 per week.
[11] Rule, p. 32938.
[12] “The probability of qualifying for the exemption increases with earnings because higher paid workers are more likely to perform the required duties.” Rule, p. 32937.
[13] 2004 Final Rule, p. 22191. https://www.govinfo.gov/content/pkg/FR-2004-04-23/html/04-9016.htm
[14] 2019 Final Rule, pp. 51238, 51240. https://www.govinfo.gov/content/pkg/FR-2019-09-27/pdf/2019-20353.pdf
[15] The 2004 Final Rule nearly tripled the salary level because it was the first adjustment in nearly three decades. Despite the large increase, the 2004 Rule did not affect nearly as many white-collar employees as will the current Rule, even after accounting for the growth in the labor force which increased by less than 14% between 2004 and 2023.
[16] Because future salary levels only depend on the salary distribution in the South region, only reclassification decisions to hourly pay, or the reduction in employment of affected employees in the South region will impact future salary levels.
[17] Changes in the California minimum wage are linked to inflation, but in some years the percentage increase will be less than the inflation rate.
[18] It is ironic that the Rule will cause an increasing share of the employees in the lower part of the non-hourly pay distribution to be blue-collar workers and white-collar workers in named occupations that are exempt from the FLSA (e.g. teachers). With each automatic update the salary level will be set by calculating the 35th percentile of a pay distribution that is increasingly unrelated to the pay of workers in executive, administrative, and professional positions.
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