Labor laws are meant to protect workers’ health and livelihoods.
However, according to an April report from the Education & The
Workforce Committee Democrats, the penalties companies face for
violating the laws — including the minimum wage law — rarely match
the severity of their offenses.
In fact, according to Anna Stansbury, the Class of 1948 Career
Development Assistant Professor at the MIT Sloan School of
Management, it often makes more financial sense for companies to
violate wage law than to comply.
In a new working paper, Stansbury used cost-benefit analysis to
demonstrate how current minimum wage enforcement structures in the
United States and the United Kingdom incentivize noncompliance and
quantify the policy changes needed to protect workers.
Wage theft is widespread in both the US and the
UK
In the United States, the Fair Labor Standards Act (FLSA) sets
out a nationwide minimum wage, as well as overtime protections.
While some states set their own higher minimum wages that supersede
federal law, 40% of the country’s workers live in the 21 states
where the FLSA minimum wage prevails. In the United Kingdom, the
same minimum wage statute applies country-wide.
While the scope of unidentified noncompliance is difficult to
measure, surveys and spot checks suggest wage theft is a
significant problem in both countries. In the U.S., random
inspections have found that as many as 40% of fast-food restaurants
and 85% of garment industry employers were underpaying
workers.
But why is noncompliance so widespread when it carries legal and
financial risk? To answer that question, Stansbury drew on two
decades of data on wage violation cases and penalties to compare
the profits a firm might realize from breaking the law to the
potential costs of being caught.
Penalties for noncompliance are low
In the U.S., all companies caught violating the FLSA must pay
affected employees back wages — but usually, that’s where
enforcement ends. In about a third of cases, the U.S. Department of
Labor (DOL) requires companies to pay additional “liquidated
damages” equivalent to wages owed. In just 6.5% of cases, repeated
or “willful” violators face civil monetary penalties, typically
ranging from 2 cents to 29 cents per dollar of wages
owed.
As Stansbury pointed out, the penalties for companies that
commit wage theft are far lower than those individuals would face
for thefts of equivalent value. Shoplifting goods worth $2,500 or
more can potentially lead to imprisonment in every state — but
while criminal charges for corporate wage theft are possible, they
are vanishingly rare. Between 1994 and 2020, the DOL prosecuted
only 38 criminal cases, none resulting in prison sentences.
Criminal prosecution is also unusual in the U.K., and while
penalties are more common, companies’ financial risk remains
low.
Discovery of violations remains rare
Both the U.S. and the U.K., Stansbury explained, using a
two-track mechanism to enforce the minimum wage. Violations may be
discovered during inspections — conducted by the DOL in the U.S. —
or employees may report violators or pursue court action.
However, insufficient resources pose a barrier to enforcement in
both countries. In the United States, Stansbury found that the DOL
rarely catches companies breaking the law and that reports from
affected employees are unlikely to make up the gap.
“Often, workers don’t realize they’re being underpaid,”
Stansbury said. “For example, workers might not know that they
should be paid for cleaning up after their shift, or they may be
incorrectly classified as contractors instead of employees.”
Stansbury noted that concerns about retaliation can also be a
major barrier to reporting. “Workers at the bottom of the labor
market have less power. Besides the risk of losing their jobs,
employers can punish them in other ways, like by giving them fewer
shifts.”
Misaligned costs and benefits
With companies unlikely to be caught and even more unlikely to
face meaningful consequences for violations, paying below minimum
wage comes with low risks and high potential benefits.
According to Stansbury’s cost-benefit analysis, a typical U.S.
firm would need to expect a 48% to 83% probability of a failed DOL
inspection or a 25% likelihood of court action to incentivize
compliance — an order of magnitude higher than current levels. Even
in the fast food industry, which inspectors often target, Stansbury
estimated that each firm has only around a 1.4% chance of being
caught violating minimum wage laws in any given year.
While the odds of being caught are higher in the U.K., they
remain well below the threshold required to make compliance the
financially beneficial choice for companies. And under these
conditions, raising the minimum wage will only make noncompliance
more profitable.
This misalignment doesn’t just hurt workers — it also harms
companies that choose not to break the law.
“If companies do not have a financial incentive to comply with
the minimum wage, it creates a race to the bottom dynamic,”
explained Stansbury. “companies that want to comply with the law
and pay their workers fairly may be outcompeted. Enforcement is not
just beneficial for the underpaid workers, but also enables ethical
companies to compete in the labor markets.”
Realigning incentives through policy change
Reducing wage violations and creating a level playing field for
ethical companies will require a two-pronged approach, Stansbury
said.
“If penalties are very low, then enforcement probabilities need
to be implausibly high — and if enforcement probabilities are low,
then penalties need to be disproportionately punitive,” she
explained. “For an effective enforcement system, you need action on
both fronts.”
Data show that these actions are practical. In several states,
recent minimum wage increases were paired with higher penalties for
violations and expanded enforcement, effectively reducing
noncompliance.
“In the U.S., it should be standard practice to require the firm
to pay back wages and liquidated damages — meaning the firm pays
twice the cost of the wages,” Stansbury argued. “Both countries
should also impose much larger penalties on the worst violators and
increase their use of criminal prosecution.”
- Penalties for noncompliance are low
Matthew Aliberti
MIT Sloan School of Management
7815583436
bayerc@mit.edu