Paychex reported a slight increase in job and wage growth at small businesses in May, although the pace of wage growth dipped slightly compared to last year.

The Paychex | IHS Markit Small Business Employment Watch, which Paychex compiles with the research firm IHS Markit, found the Small Business Jobs Index increased 0.07 percent to 99.60 in May. Hourly earnings growth increased 2.59 percent year over year by $0.67 to $26.61. That was up 2.59 percent compared to last year, but the pace of annual wage growth was down from its peak of 2.96 percent in June 2017.

“In May we had a slight uptick for the month in the small business jobs report part of it, but we’re still down about 0.7 percent from last May,” said Paychex president and CEO Martin Mucci. “We’re continuing to see continuing moderate job growth in a tight labor market.”

The South led the way among the regions of the country in terms of employment growth in May, according to Paychex, while the West ranked highest in terms of wage growth. Texas ranked in first place for state job growth, while Arizona stayed in first place in terms of annual hourly earnings growth. Denver continued to lead among metropolitan areas on job growth, while Phoenix remained in first place among metro areas on wage growth.

“Across the country, all regions are down,” said Mucci. “The South is still in the best shape, driven by better manufacturing. Job growth there is up about 3 percent. Texas moved into the top spot, driven a lot by Houston. As oil prices have come back, Houston has seen a pretty nice resurgence in small business job growth. In Houston, it’s up a little over 2 percent from last year, while Dallas is actually down. It’s kind of a tale of two cities in Texas.”

In terms of industries, the construction industry has been above 100 on jobs growth for the past six years, while the combined trade, transportation and utilities sector led the way on weekly earnings growth among industries at 4.07 percent. At nearly 4 percent, the leisure and hospitality sector has had the strongest hourly earnings growth each month of 2018. On the other hand, the professional and business services sector has decelerated to 2.17 percent growth in May, ranking last among industry sectors in 2018.

Paychex Small Business Employment Watch May 2018

Wage growth is still disappointing, though, considering how tight the labor market is right now, with the unemployment rate sliding last month to 3.9 percent, the lowest rate since 2000.

“The hourly earnings growth slowed to about 2.6 percent, so it’s down slightly,” said Mucci. “That’s still the big question: Why would the hourly earnings growth hang around that 2.6 percent annual growth when it’s such a tight labor market? There are not a lot of clear answers there. One thing we’re seeing is that part-time employees had about 3.4 percent earnings growth, and full-time employees had about 2.5 percent. I think because of the minimum wage going up, small businesses are hiring more part-time employees. It keeps their costs a little bit lower, and that growth of part-time could be holding the overall wage increase down a little bit too.”

Tax reform may be playing a role in small business hiring decisions too. Mucci cited the high levels in the National Federation of Independent Businesses’ Small Business Optimism Index over the past year and a half.

“It’s interesting that the high scores were for earnings trends and for capital investment trends,” he said. “We wondered with tax reform and with wages staying lower than we expect, maybe the tax reform impact is going more towards earnings and profitability. We also do hear anecdotally that some of the investments are going to capital investment and automation and things like that versus wage increases, but I have to think that wage increase has to come up at some point, if you’re going to get the right people behind the tight labor market. If you’re going to hire, you’re going to need to raise those wages, but we just haven’t seen it yet.”

He believes accountants should continue to advise clients to be careful about how they classify employees, pointing to a California Supreme Court decision last month that is expected to make it more difficult for employers to classify workers as independent contractors.

“It’s putting more of a burden on the employer to prove that they’re not employees, that they’re contractors,” said Mucci. “I think accountants are going to be asked this more and more across the country, to really help their clients define whether they have employees or whether they have contractors.”

Some states, such as New York, are responding to the federal tax reform and its limits on the state and local tax deduction with new options for allowing taxpayers to pay their state taxes to state-run charitable funds or to have more money withheld in payroll taxes. But with the IRS signaling last week that it plans to issue regulations to foreclose the charitable deduction workaround, Mucci is advising caution. Even though Paychex is based in Rochester, N.Y., he hasn’t yet seen any employers trying to take advantage of New York State’s new payroll tax option.

“We haven’t seen or heard of anyone moving to that yet,” he said. “They’re still clarifying the rules on that, but it’s still quite confusing. Now with the IRS coming out and saying, “Hey, we’re really not supportive of those things, we’re going to be looking deeper into this,’ I would doubt many employers are going to try to risk implementing a payroll tax on their employees to save them the state income taxes if they know it’s going to have be reversed, which would put them in a bigger mess. Right now the burden is kind of on the state to say, ‘Gee, look what you’re doing to folks, that this is not deductible on your state income tax.’ If the employer implements that payroll tax and it doesn’t hold up, then suddenly the employer is in a tough spot. We continue to watch that very closely, but I’m not sure what’s going to happen until somebody tries it and it’s either reversed or not allowed by the IRS.”

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Michael Cohn

Michael Cohn

Michael Cohn, editor-in-chief of AccountingToday.com, has been covering business and technology for a variety of publications since 1985.