President Trump has made taxation a major part of his campaign this time around. Remembering that tariffs are another word for "import tax," Trump has proposed multiple types of new tariffs, including a 60 percent tariff on Chinese goods and a 10 percent universal tariff. On the other hand, he has proposed exempting taxes, including exempting Social Security benefits and exempting tips. I can add another tax exemption to that list: overtime.
Earlier this month, Trump proposed exempting overtime workers from taxation while at a campaign rally in Tucson, Arizona. Vice Presidential candidate Senator J.D. Vance clarified that this exemption would cover both income and payroll taxes. Politically, Trump's proposal makes sense since it is an attempt to pander to blue-collar voters. For an economy in which inflation has increased rapidly relative to historic averages and where wages cannot keep up with the increased cost of living, it can sound appealing to employees. Employers also like it because it de facto acts as a raise that the employers themselves do not have to pay. However, it begs the question as to whether such a policy makes sense.
First, there is a matter of the price tag. Last week, the bipartisan Committee for a Responsible Federal Budget (CRFB) released its estimates on the exemption while comparing it to some other cost estimates. On a static basis, it would cost $1.7 billion over the next decade.
Then there is the CRFB's dynamic estimate of Trump's proposal costing $6 trillion over the next decade. As CRFB admits, this is an extreme case estimate because it assumes that all eligible workers switch from being salaried to hourly. Employers could plausibly exploit the loophole and convert their workers from salaried to hourly workers. Why would the exemption encourage hourly pay over salary pay?
Under the Fair Labor Standards Act (FLSA), any FLSA non-exempt and hourly workers are legally obligated to pay 1.5 times the regular rate. At least with the current tax code, there is a consistent tax treatment across workers. With Trump's proposal, it would be a zero tax rate on a completely unprincipled definition of income. From the employee's perspective, it would mean paying less taxes and higher take-home income. For employers, it means paying less in payroll tax. It certainly would not translate into more government revenue since the extra work would generally be non-taxable.
As the Tax Foundation points out, this exemption would "increase time spent on overtime decisions for employees and worker classification arrangements between employees and employers purely for tax purposes, distracting them from productive activity." It would also increase compliance and administrative costs. Why?
Because it would not be exempting a portion of wage income. Instead, this exemption would be based on hours worked, which would mean additional reporting of hours. As such, it would be more complicated than Trump's proposals to exempt Social Security benefits or tips.
While exempting overtime from taxes could create a small boost in hours worked and economic output, I have to question the extent to which it would. As the Competitive Enterprise Institute reminds us, employers have found ways to work around the FLSA. This overtime rule also would not apply to self-employed workers, managers, or freelance workers since they are not covered by FLSA to pay overtime. The number of employees that would be able to work additional overtime would thus be small, thereby rendering the most probable outcome as marginally positive economic input.
Lowering statutory tax rates could create the increase in labor supply and economic output without complicating the tax code. Yet Trump is opting for the costly choice that will complicate the tax code and increase administrative costs while doing little to boost the economy.
Instead of buying votes, maybe Trump (or any other politician) could focus on fitting their tax proposals in a way that match revenues to expenditures while being able to pay down the debt. Creating solvency while not ruining ourselves with massive amounts of debt. What a concept! Yes, reducing taxes can and should be part of a greater plan to bring this country's fiscal state into one of good health. Yet all Trump is proposing is distortive tax reform in a bleak fiscal environment in hopes of getting re-elected. We might deserve better, but as both Trump and Harris show us with their policy proposals, we are not going to get better tax policy with the next president.
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