Former President Donald Trump suggested on Thursday night that money from overtime work be completely free from income tax. The overtime tax exemption would join Trump’s increasing list of recently proposed tax cuts, which already includes exemptions for Social Security payments and tipped income.
Traditional Basis
We project a lower-bound revenue drop of $680.4 billion over ten years if all overtime compensation is excluded from individual income tax. This most recent proposal would boost the deficit rise of Trump’s whole tax and tariff plan to $2.0 trillion over ten years, in addition to increasing the $6.1 trillion in tax cuts that he has previously pledged to $6.8 trillion. Together with the income tax exemption, further exempting all overtime pay from employee-side payroll taxes (6.2 per cent for Social Security and 1.45 per cent for Medicare) would result in a $1.1 trillion decrease in tax receipts over a ten-year period.
The eventual income effect is unpredictable due to the lack of design detail. For instance, the cost would surpass $1.5 trillion over a ten-year period if the policy exempts overtime payments from both sides of the payroll tax and income tax. On the other hand, a plan that is solely specifically designed to exclude the 50% overtime premium from income tax would, on a traditional basis, result in a reduction of around $227 billion in revenue over a ten-year period.
Exempting overtime compensation
from income tax will greatly skew labour market decisions, even though the plan lacks important details. If the benefit is not extended to salaried employees who are exempt from the overtime regulations of the Fair Labour Standards Act (FLSA), employees would be incentivised to work more overtime, and hourly or salaried non-exempt employment would become more appealing.
firms would also be impacted by Trump’s idea as workers would find methods to ask for more overtime, which would increase labour expenses for firms. The rising appeal of overtime labour may be a good fit for some firms’ current business practices. As overall labour expenses increase, other businesses might need to take a more active approach to limiting overtime demands.
By examining the Bureau of Labour Statistics predictions for 2023, which indicate that 34.4 million workers reported working more than 40 hours per week, we can demonstrate the possible income loss of gaming (apart from any increases in extra hours worked). In contrast to overtime pay as defined by FLSA regulations, all compensation related to working more than 40 hours per workweek would be exempt from income taxes and both sides of the payroll tax. This may have a $3.1 trillion fiscal impact over ten years (not counting interest expenses).
Billions of dollars
is the conventional revenue estimate for exempting all overtime pay from individual income tax in 2025, 2026, 2027, 2028, 30, 2031, 2032, 2033, and 2034.
Paying overtime while maintaining consistent behaviour -$18.9 -$19.7 -$20.5 -$21.3 -$22.1 -$23.0 -$23.9 -$24.8 -$25.8 -$26.8 -$226.8 $472.5 $492.1 $511.9 $532.4 $553.7 $575.4 $597.8 $620.8 $644.5 $668.9 $5.670.0 Exempt 50 per cent premium portion of overtime pay only from income tax
-$56.7 -$59.1 -$61.4 -$63.9 -$66.4 -$69.1 -$71.7 -$74.5 -$77.3 -$80.3 -$680.4 Exempt Overtime Pay from Income Tax
Exempt Overtime Pay from Income Tax and Employee-Side Payroll Tax -$92.9 -$96.7 -$100.6 -$104.6 -$108.8 -$113.1 -$117.5 -$122.0 -$126.6 -$131.4 -$1,114.2 Exempt Overtime Pay from Income Tax and Full Payroll Tax -$129.0 -$134.4 -$139.8 -$145.3 -$151.2 -$157.1 -$163.2 -$169.5 -$175.9 -$182.6 -$1,547.9 Exempt All Pay Associated with Working More than 40 Hours from Income Tax and Full Payroll Tax -$261.4 -$272.2 -$282.9 -$293.8 -$305.2 -$316.9 -$328.9 -$341.1 -$353.7 -$366.7 -$3,122. 8.
Note: Revenue projections do not include behavioural shifting to raise overtime pay since they maintain the ratio of overtime pay to total compensation constant. In estimates 1-4, overtime compensation is assumed to be taxed at an average marginal income tax rate of 12 per cent; in estimate 5, the average marginal income tax rate is assumed to be 18 per cent.
Source: Author estimates derived from CBO and BLS data.
Income from overtime labour should not be treated any differently than income from a taxpayer’s first 40 hours of employment from the standpoint of tax policy. Employers are required to pay hourly and FLSA non-exempt workers 1.5 times the standard rate for any hours above 40 in a workweek. For tax reasons, overtime compensation is added to all other income, ensuring that all employees receive the same tax treatment. In contrast, Trump’s plan imposes a “zero tax rate on a completely unprincipled definition of income,” as former director of the Congressional Budget Office Doug Holtz-Eakin described it.
An exemption for overtime labour would divert workers’ attention from more productive tasks by increasing the amount of time spent on worker categorisation agreements between employers and employees and overtime choices for employees only for tax purposes. Long-term economic development and a little increase in the labour supply would result from the proposed tax exemption, although there are simpler methods to achieve this, such as decreasing statutory tax rates, that avoid adding further exemptions to the tax system or encouraging economically inefficient gaming.
Compared to Trump’s other proposed exemptions for gratuities and Social Security, both of which are currently subject to some tax reporting requirements, the exemption for overtime is a more complex idea. Rather, a whole new distinction in the tax code is introduced by exempting a portion of pay income based on hours worked. This necessitates new administrative checks and more information reporting hours, most likely from employers and workers.
To put it briefly, allowing overtime would undermine neutrality by favouring some employment arrangements over others, raising compliance and administrative expenses, and needlessly complicating the tax law.
Notes on Revenue Estimation
According to estimates from the Bureau of Labour Statistics, premium and overtime pay account for around 4.2 per cent of salaries and earnings, or 3.0 percent of total compensation. That comes to around $5.7 trillion in overtime and premium pay over a ten-year period, assuming that ratio stays the same. By maintaining the ratio constant, we anticipate that a second Trump administration will overturn the recent Biden administration regulation change that expanded overtime compensation to a wider group of workers.
We eliminate any behavioural shifting to increase overtime hours worked or reclassify compensation arrangements to qualify for overtime pay by maintaining the ratio of overtime pay to total compensation constant. This would provide a substantial incentive for such behaviour.
We estimate that the marginal income tax rate on overtime compensation is 12 percent on average. We assume that overtime compensation is taxed at a marginal income tax rate of 18 percent on average for our upper bound estimate. Trump has also suggested making the 2017 tax bill permanent, thus both of these rate estimates are predicated on current law rates.
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