Three months after proposing to end federal taxing of tips—an idea promptly confiscated without compensation by Kamala Harris’s campaign—Donald Trump doubled down by saying “we will end all taxes on overtime” if he’s elected president. Without a doubt, millions of Americans who resent government’s ravenous bite out of their paychecks immediately began contemplating just how much of their income they could shield from the tax man that way.
Tips and Overtime for Everybody!
“Can someone get paid in primarily tips and overtime?” quipped the Cato Institute’s Scott Lincicome. “Asking for a few million friends.”
On a more serious note, the Competitive Enterprise Institute’s Sean Higgins thought exempting overtime pay “wouldn’t necessarily be a bad idea…but, overall, it is not likely to make that much of a difference to most workers because overtime isn’t that common.” He’d been more strongly supportive of exempting tips because that “would put more money directly in the pockets of working Americans without either costing employers more or raising prices for customers.” He also liked that freeing tips from taxation would “keep tipping out of the reach of the regulatory state.”
But what if overtime pay becomes more common precisely because it’s not taxed?
The people at the Tax Foundation expect that’s exactly what will happen, just as Lincicome joked. Thinking through the implications of exempting overtime pay from taxation, Garrett Watson and Erica York warned that “exempting overtime pay from income tax would significantly distort labor market decisions. Employees would be encouraged to take more overtime work, and hourly or salaried non-exempt jobs may become more attractive if the benefit is not extended to salaried employees who are exempt from Fair Labor Standards Act (FLSA) overtime rules.”
The Tax Foundation’s Alex Muresianu had a similar reaction to the proposals to exempt tips from taxes from both Trump and Harris. He thinks “the proposal would make more employees and businesses interested in moving from full wages to a tip-based payment approach.” He foresaw “substantial behavioral responses, such as previously untipped occupations introducing tipping.”
Of course, a world in which more Americans receive their pay beyond the reach of the tax man is a welcome prospect to many of us. If politicians want to phase out income taxes, even unintentionally, who are we to complain? Hang on a minute while I set up my virtual tip jar. In fact, there’s precedent for government policy around wages to cause major unintended consequences. Take, for example, employer-provided healthcare coverage.
Government Policy Has Distorted Compensation Before
“One of the most important spurs to growth of employment-based health benefits was—like many other innovations—an unintended outgrowth of actions taken for other reasons during World War II,” according to the 1993 book, Employment and Health Benefits: A Connection at Risk. “In 1943 the War Labor Board, which had one year earlier introduced wage and price controls, ruled that contributions to insurance and pension funds did not count as wages. In a war economy with labor shortages, employer contributions for employee health benefits became a means of maneuvering around wage controls. By the end of the war, health coverage had tripled.”
Given that health benefits became a substitute form of compensation to escape a wage freeze, it’s not difficult to imagine the United States moving toward a situation in which a lot more people receive the bulk of their pay from untaxed tips and overtime pay.
But if income taxes are effectively phased out for millions of Americans as an unintended consequence of presidential promises intended to please crowds and buy votes rather than as thought-through tax policy, the result could be chaos—and panicked reactions from the political class.
The Tax Foundation expects exempting overtime pay to reduce federal revenues by anywhere from $680.4 billion to $3.1 trillion over 10 years. That’s a very wide range because of uncertainty as to just how broadly the exemption would be applied and the potentially massive degree to which worker compensation could change as Americans seek to benefit from taking their pay in untaxed form.
Similarly, exempting tips would reduce revenues by at least $107 billion over 10 years, though the amount could be much larger as tipping becomes more widespread.
A Lost Opportunity for Real Tax Relief?
Personally, I don’t mind in the least contributing to lower federal revenue collections; it’s not like the clowns in Washington, D.C. are on track to control spending or address the looming debt disaster. But we should worry about restructuring our entire system of worker compensation around yet another ill-considered effort to buy votes. Worse, the political class will almost certainly respond to plunging revenues with draconian and even more poorly considered schemes to scrutinize our finances and pick our pockets to refill federal coffers. We could lose the opportunity for real tax reform such as an extension and expansion of the Tax Cuts and Jobs Act passed when Trump was in the White House.
“Trump is losing the tax plot by promising all sorts of costly tax giveaways that will make it hard and maybe impossible to extend the pro-growth components of his reform,” The Wall Street Journal editorial board cautioned about the Republican candidate’s overtime pay and tips exemption proposals, as well as his recent scheme to remove the cap on state and local tax deductions for residents of high-tax states. It added that Trump’s promises “undermine a major goal of tax reform, which is to make the code more efficient so it raises revenue with the least economic distortion.”
People are entitled to keep the money they earn, and lower taxes are better taxes. But like all uses of state power, proposals for tax relief should be more than candy tossed to the crowd in hopes of winning favor. They should be thought through as part of a larger plan to fund whatever about the government needs funding (not so much, I would suggest), without driving businesses, organizations, and individuals into contortions to take advantage of poorly conceived changes to the tax code.
Maybe federal officials and those aspiring to the job could even fit their tax ideas into a larger framework that matches revenues to expenditures and pays down debt. Wouldn’t that be a refreshing change?
By all means, let’s see more proposals for tax reform, especially tax reduction. Perhaps exempt overtime and tips as part of an overall plan. But let’s see these ideas proposed as policy, not just payoffs for votes.
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