Obama’s Labor Market Mischief

Richard Epstein*

Richard Epstein

Richard Epstein

Under the Fair Labor Standards Act of 1938 and its subsequent amendments (FLSA), Congress has delegated to the President the power to set overtime regulations for all public and private employees throughout the United States. On March 13, 2016, President Obama directed Thomas E. Perez, head of the Department of Labor (DOL), to “modernize and streamline the existing overtime regulations for executive, administrative, and professional employees,” which, in his view, “have not kept up with our modern economy.” The Department of Labor conducted exhaustive hearings on the matter, during which it received comments from close to 300,000 individuals and organizations.

In May 2016, following these hearings, the Department issued its Overtime Final Rule that showed how little it had learned from the process. It did nothing to adjust the definitions of EAP (executive, administrative, and professional employees) workers. But it did raise the minimum salary level for exempt EAP workers from $23,660 per year, or $455 per week, to $47,892 per year, or $921 per week. The regulation also included a provision that automatically raised the minimum salary level every three years to take into account the effects of inflation.

This rule, which generated widespread consternation in government and business, was scheduled to go into effect on December 1, 2016. But on November 22, 2016, in Nevada v. U.S. Department of Labor, Judge Amos L. Mazzant of the Eastern District of Texas, an appointee of President Obama, issued a nationwide preliminary injunction that blocked its implementation at the request of 21 states (all but Louisiana with Republican governors) and a number of private businesses. Under the FLSA, the exemption only applies to workers paid on a salary (as opposed to an hourly) basis who must be paid the minimum amount set by the regulation in question. Most critically, the FLSA regulations contain a so-called “duties test” that must be met in order for employees to be treated as exempt
EAP workers.

Executives typically have management powers and the ability to hire and fire. Administrators do office and non-manual work related to firm management. Professionals have to engage in intellectual work that, with study, allows them to acquire “advanced knowledge . . . in a field of science or learning.” In the end Judge Mazzant held that the regulation failed because in raising the minimum level to $47,892, it did not take any steps to make sure that EAP workers under that level were not exempt from the overtime provision. In other words, the duties component of the test had to be satisfied independently of the hourly test.

In reaching his decision, Judge Mazzant upended the usual expectation that the government is given broad discretion in interpreting its own regulations. Thus in the course of its argument, the Department of Labor insisted that the well-known 1997 Supreme Court decision of Auer v. Robbins gave the Secretary of Labor virtually full discretion in fleshing out the details of the regulations that it promulgated under the FLSA. In that decision, Justice Scalia held that the Secretary could refuse to classify police sergeants and lieutenants as bona fide EAPs because they were subject to reductions in pay for various disciplinary infractions. The supposed standard for upholding an interpretation was that the interpretive rule was not “plainly erroneous or inconsistent with the regulation.” But it was laughable nonetheless because it was at enormous variancewith ordinary language, which everywhere describes sergeants as “field supervisors” and lieutenants as the supervisors of a “bureau, squad or unit.” Notwithstanding Auer’s indefensible intellectual acrobatics, Judge Mazzant decided to apply a “plain meaning” test that struck down the regulation on the simple ground that many workers earning below the new threshold in fact occupy bona fide EAP roles. Yet the Secretary made no effort to provide separately for any of those cases. Interestingly enough, the same objection did not succeed against the lower, previous minimum salary number given that few if any EAPs earn such low wages.

In making this decision, however, Judge Mazzant turned away another challenge to the FLSA insofar as it applies to public employees, to whom his decision devoted virtually exclusive attention. This more fundamental challenge should have been based on the sensible view that the United States has no business regulating the wages or overtime pay of state government employees. In principle, the strongest argument in favor of this position is that the United States and the states should be regarded as coequal sovereigns, each within its own defined territory. Under that conception, the states should be able to organize the internal affairs of all its own agencies as it sees fit. In National League of Cities v. Usery (1976), Justice Rehnquist did not embrace this strong originalist conception, but he did hold that the states were exempt from federal oversight insofar as they discharge “traditional governmental functions”—a phrase that the Court never fully defined. The unworkable nature of that needless distinction led the Court in 1985 to overturn National League of Cities in Garcia v. San Antonio Metropolitan Transit Authority, given its professed inability to decide whether mass transit in a metropolitan area fell within the class of traditional government functions.

Unfortunately, this whole judicial episode was misconceived, because in the post-New Deal Era, there is no principled reason at all to distinguish between traditional and novel government functions when both are regarded as equally legitimate. The correct result is that all states should be liberated from any statute, including the FLSA, that seeks to set the wages and hours of a state’s own employees. Judge Mazzant briefly noted correctly that the Court did some modest backtracking from Garcia in Printz v. United States, which held that the federal government could not require state and local enforcement officers to conduct background tests on prospective handgun purchasers. But he was surely correct to conclude that Garcia is still the law. Ideally, the model of coequal sovereignty is most faithful to our constitutional traditions. A reconstituted Supreme Court could solve a large fraction of this problem by ditching Garcia and expanding the exemption under National League of Cities so that it covered all state and local workers, regardless of their function.

Nonetheless, in the short run, the new Trump administration should not wait to find out whether Judge Mazzant’s edgy decision will be sustained on appeal. On day one in office, President Trump should scrap the DOL’s new overtime rule: Far from modernizing and streamlining business, the new rule, as is evident from the torrent of objections, throws a massive wrench into the new economy. The simplest point here is that the “hour” is no longer the gold standard of compensation for many workers. The gig economy, for example, pays its workers by the job and not by the hour. It is impossible for these employers to monitor the hours of workers who, under their contracts, have complete freedom to decide whether or not to take any given assignment. It becomes the road to economic ruin to impose rules of this sort when the penalties for noncompliance are so high.

The same can be said with respect to graduate students whose laboratory work is a mixture of study and employment, where it is again impossible to tease out the one component from the other. The objection also applies to tech start-ups, whose employees receive a huge chunk of their compensation in the form of stock options and future bonuses, which are largely ignored under the myopic FLSA hourly formula. None of these cases gave rise to much difficulty when the base wage was set low, but they cause enormous confusions to millions of workers whose responsibilities are not accurately measured by their base rate of compensation.

Nonetheless, the DOL has buried its head deeply in the sand in promulgating the regulation. Its own original assessment of the impact of its new overtime rule is a perfect self-parody of economic analysis. The stated point of the rule was to raise “salary threshold at the 40th percentile of weekly earnings for full-time salaried workers in the lowest wage Census region in the country, currently the South.” The meaning of this particular figure is never explained. Nor did DOL come to grips with the massive disruption that the new overtime rule could cause to many established forms of business. Instead, it adopted the naïve conclusion that “managerial costs” will be about $224 million, which is “based on the median compensation of a manager multiplied by the assumed average 5 minutes per week for the additional monitoring (i.e. more than one hour per quarter) multiplied by the total number of directly affected workers who work overtime either regularly or occasionally but on a regular basis.”

At no point does the DOL even ask whether to include in its calculation the key decisions that firms must make on whether to keep workers below the threshold, or to raise them above it, in order to avoid the heavy monitoring costs. Nor does it ask whether firms will choose to lay off some workers or redefine job classifications in ways that minimize the impact of the new rule. The DOL also fails to examine whether, and if so how, these firms will have to adjust other salaries to keep relative compensation in order. And, of course, the DOL ignores the possibility that some workers are opposed to the shift, given the loss of potential status from having to punch a clock, and the possibility that some departments might have to close or restructure or let go of some workers. The DOL model also assumes that it is easy to set in place the systems needed, and that the firms in question need not worry about inspections, fines, and potential civil liability for noncompliance with the rules. It is laughable to think that the fight over this rule is about the allegedly $224 million per annum in quantified managerial costs or even the $1.2 billion in pay increases that are identified by the DOL. The greatest sin of the DOL is that it assumes blithely that neither private nor government firms and agencies respond to incentives, so that it can reduce a complex economic inquiry into a simple set of mathematical calculations not worth the paper that they are written on.

Nonetheless, the DOL is largely unrepentant; in response to Judge Mazzant’s decision, it wrote: “We strongly disagree with the decision by the court, which has the effect of delaying a fair day’s pay for a long day’s work for millions of hardworking Americans." But once again this pronouncement suggests that the DOL knows what counts as a fair day’s pay for the millions of workers who are subjected to the rule. In so doing, it makes the most fundamental mistake in economic analysis. It assumes that the agreements that are in place do not reflect the revealed preferences of the workers who have signed on to these deals. It is of course the case that workers want to receive higher wages, and every employer would prefer to pay less. It is just these two pressures that drive a competitive market to set wages as they do. There is absolutely no reason to think that the optimal pay schedule for overtime is one-and-a-half of basic wages. A huge number of firms will have to change their job classifications and reorganize their work and production schedules to avoid overtime payments. Yet the DOL ignores this elephant in the room, so little does it understand the market that it regulates.

The only way in which to achieve permanent wage increases is to reduce the many impediments on the FLSA and other statutes that make it harder for employers and workers to achieve productivity gains. The fruitless overtime rule of the DOL, if implemented, will probably result in resource losses that exceed, by at least an order of magnitude, the paltry sums that it purports to transfer from employers to workers. The quicker the DOL is pushed to the sideline, the better it is for the American economy, its workers, and employers and consumers alike. Let’s hope that the change in presidential administration leads to a long overdue change in labor market regulation. 

*Considered one of the most influential thinkers in legal academia, Richard Epstein is known for his research and writings on a broad range of constitutional, economic, historical, and philosophical subjects.