What was as soon as an obscure exemption handed by Alabama again in 2023 as a response to the dangerous labor market following the COVID-19 shutdowns has come to the forefront of coverage in lots of states, due in no small half to President Donald Trump’s 2024 reelection marketing campaign. Exempting all or a mixture of suggestions, additional time, and bonuses from earnings taxA tax is a compulsory cost or cost collected by native, state, and nationwide governments from people or companies to cowl the prices of normal authorities providers, items, and actions.
is fashionable with voters, although seemingly not a excessive precedence for many. No matter reputation, although, standing for sound tax coverage continues to be the best factor to do, particularly when there are different, extra economically environment friendly, means to offer tax aid (significantly if the purpose is to supply aid to lower-income households).
Proponents of such tax exemptions argue that they provide a lifeline to employees in low-wage and labor-intensive sectors. For tipped employees—corresponding to waitstaff, bartenders, and supply drivers—suggestions typically represent a good portion of earnings, supplementing base wages that will fall beneath the usual minimal wage in some states. Equally, additional time exemptions would profit hourly employees—assume nurses, manufacturing unit employees, or firefighters—who depend on further hours to make ends meet. In Alabama, the one state with an lively additional time tax exemptionA tax exemption excludes sure earnings, income, and even taxpayers from tax altogether. For instance, nonprofits that fulfill sure necessities are granted tax-exempt standing by the Inside Income Service (IRS), stopping them from having to pay earnings tax.
as of 2025, knowledge have steered a lift in labor provide and private earnings. Bonuses, typically tied to efficiency or seasonal work, may additionally change into extra rewarding if untaxed, incentivizing productiveness.
Past particular person advantages, supporters contend that these exemptions may stimulate native economies. Staff with greater disposable earnings usually tend to spend, boosting demand for items and providers. In states like Kentucky or North Carolina, the place payments suggest exemptions beginning in 2026 or earlier, lawmakers envision a virtuous cycle: untaxed earnings gasoline consumption, which in flip helps companies and job creation. Politically, the thought resonates with a broad swath of voters: 73 p.c of People throughout celebration traces supported no taxes on suggestions in a 2023 ballot.
The pattern of exempting suggestions, additional time, and bonuses from taxation has roots in each federal rhetoric and state-level innovation. On the federal stage, proposals to remove taxes on suggestions and additional time gained traction throughout the 2024 presidential marketing campaign, with Donald Trump and Kamala Harris advocating for such measures as a approach to help service employees and incentivize further hours. Even earlier than this, states had taken up the mantle, with Alabama main the cost as the primary to enact a no-tax-on-overtime coverage from 2024, reporting a subsequent 5 percent spike in volunteered additional time. Different states, corresponding to North Carolina with its “No Tax on Ideas, Additional time, Bonus Pay” invoice (Home Invoice 11), purpose to increase exemptions to the primary $2,500 of annual bonuses alongside suggestions and additional time. Kentucky, Maryland, Nebraska, and New Jersey have launched comparable laws, typically tying these exemptions to broader tax aid packages or minimal wage changes. This wave of exercise displays a broader sentiment: employees need to hold extra of their earnings, particularly in industries the place suggestions or additional time kind a good portion of earnings.
Why It’s Unhealthy Coverage
Regardless of its populist attract, exempting suggestions, additional time, and bonuses from taxation is a flawed concept that undermines financial equity, distorts labor markets, and jeopardizes tax revenues. First, it introduces extreme horizontal inequity within the tax code. Two employees incomes the identical annual earnings may face vastly completely different tax burdens merely due to the character of their livelihoods.
Think about two taxpayers incomes $30,000 yearly in a state with a flat 5 p.c earnings tax: Tracy, a secretary, and Bob, a waiter. Tracy earns all earnings as wages, whereas Bob earns $20,000 in wages and $10,000 in suggestions. Below present regulation, each declare the $14,600 normal deduction and owe $770 in state earnings tax. If the state passes a “no tax on suggestions” regulation, Tracy’s tax legal responsibility stays $770, however Bob’s suggestions change into exempt, lowering his taxable earnings to $5,400 and his tax to $270—a 65 p.c minimize.
Tax Situations
A resort clerk incomes $39,500 partly by means of additional time can pay much less tax than a automobile rental clerk incomes the identical quantity by means of common hours, regardless of an identical monetary circumstances. A employee given a year-end bonus will probably be topic to decrease taxes than one other employee who makes an equal amount of cash by way of solely wage.
These pattern disparities spotlight the biases inherent to such legal guidelines: they arbitrarily reward some employees over others going through the identical monetary circumstances. This arbitrary favoritism lacks a coherent coverage rationale and downsides employees unable to entry tipped or overtime-heavy roles, corresponding to these with caregiving obligations or fastened schedules.
Second, these exemptions create perverse incentives for employers, employees, and policymakers alike. By making suggestions and additional time tax-free, employers might really feel much less stress to lift base wages, successfully shifting the burden of compensation onto tax coverage somewhat than payroll. Tipping fatigue, already power within the nation, is prone to be exacerbated as extra industries reply to the incentives created by such misguided legal guidelines. Employers may additionally restructure pay to favor bonuses or additional time over hiring extra workers, lowering job alternatives and inspiring overwork. Worse, excessive earners may exploit these exemptions by reclassifying earnings as suggestions or bonuses, a loophole already flagged by tax specialists as a danger for professionals, like attorneys or consultants. This might additionally stall efforts to implement real tax reforms, with legislatures selecting to relaxation on the laurels of those fashionable (however ineffective) items of laws as simple political wins whereas subjecting the financial system to the prices of those inefficiencies.
Third, the fiscal prices of such measures are important, and they’re poorly focused. Estimates counsel that exempting additional time alone may value the federal authorities between $680 billion and $1.5 trillion over a decade, relying on whether or not the exemption additionally applies to the payroll taxA payroll tax is a tax paid on the wages and salaries of staff to finance social insurance coverage applications like Social Safety, Medicare, and unemployment insurance coverage. Payroll taxes are social insurance coverage taxes that comprise 24.8 p.c of mixed federal, state, and native authorities income, the second largest supply of that mixed tax income.
, and states are prone to see comparable proportional prices. Alabama’s expertise with its 2023 additional time tax exemption (Act 2023-421) provides a cautionary story. Initially projected to value $34 million yearly, the exemption diminished state income by $230 million in its first 12 months, with a complete value of $345 million anticipated by its July 2025 sundown. States like Montana, which just lately reversed a tip exemption, illustrate the budgetary trade-offs: misplaced income means much less funding for colleges, roads, or anti-poverty applications, typically necessitating cuts or tax hikes elsewhere. Furthermore, solely a small fraction of employees—about 2.5 p.c of the nationwide workforce are tipped, and roughly 55 p.c qualify for additional time, however don’t essentially obtain it—stand to learn, leaving a sizeable proportion of low- and middle-income earners unaffected. Certainly, among the many bottom half of hourly wage earners, lower than 4 p.c are in tipped occupations. Among the many backside quarter, the share is 5 p.c.
Lastly, these insurance policies complicate tax administration and invite avoidance. Distinguishing between common wages, suggestions, additional time, and bonuses provides bureaucratic overhead for employers and the income departments of the states, rising errors and evasion dangers. The shortage of uniformity throughout states additional muddies the waters, creating confusion for taxpayers and directors alike.
A Higher Path Ahead
Somewhat than pursuing gimmicky tax exemptions, policymakers ought to deal with structural reforms that elevate all employees with out distorting markets or draining public coffers. The place normal deductions are nicely beneath the federal deduction, rising them would offer broad-based aid, taking some taxpayers off the tax rolls altogether. Reducing marginal tax charges would enhance the returns to labor, encouraging a rise in labor provide and consequently financial output and tax baseThe tax base is the whole quantity of earnings, property, property, consumption, transactions, or different financial exercise topic to taxation by a tax authority. A slim tax base is non-neutral and inefficient. A broad tax base reduces tax administration prices and permits extra income to be raised at decrease charges.
.
Updating additional time legal guidelines to lift eligibility thresholds—at the moment simply $35,568 yearly—would guarantee extra employees obtain time-and-a-half pay with out counting on tax breaks. This tackles overwork at its supply, compelling extra employers to pretty compensate further hours somewhat than offloading the associated fee onto taxpayers.
Conclusion
The pattern of tax exemptions on suggestions, additional time, and bonuses might sound like a win for employees, however it’s a shortsighted repair with long-term drawbacks. It creates winners and losers amongst employees with equal incomes, distorts labor markets, and undermines public funds—all whereas failing to assist the American employees struggling essentially the most. A greater path lies in financial development, greater normal deductions, and strengthening additional time protections. These steps tackle among the financial pressure, on the lowest effectivity loss, making certain equity and sustainability over populist guarantees that don’t maintain up underneath scrutiny. As states and the federal authorities weigh these insurance policies in 2025, they need to prioritize options that elevate everybody, not only a choose few.