How No Tax on Overtime Will Affect Federal Revenues and Tax Fairness
As part of the One Big Beautiful Bill Act (OBBBA), lawmakers created a new tax break that allows taxpayers to deduct up to $12,500 in overtime pay from their taxable income. This new, temporary deduction will cost $90 billion dollars over the next four years, while undermining tax equity and making the tax system more complex.
What Is Overtime Work?
National standards for overtime work were first outlined by the federal government in the Fair Labor Standards Act (FLSA) of 1938. A New Deal-era law, the FLSA established the national minimum wage, set overtime pay practices, and provided child labor protections. The act mandated that employees be paid at least one-and-a-half times their usual pay rate for hours worked beyond the standard work week (40 hours). According to the Congressional Research Service, the purpose of the overtime provision was to “reduce unemployment by encouraging employers to hire more workers,” which would cost less than paying the required premium for the overtime work of an existing employee. Some working people are not covered by the overtime pay requirements: FLSA-exempt employees mostly include executive, administrative, and professional (EAP) employees. Generally, the EAP exemption applies to employees who are paid on a salary basis above a certain income threshold and whose duties meet certain tests.
Nationally, approximately 6 percent of employed individuals reported that they typically worked overtime in 2024.
No Tax on Overtime Will Reduce Federal Revenues
Under prior law, all overtime pay was subject to taxation. Under the One Big Beautiful Bill Act, taxpayers may now deduct up to $12,500 annually of overtime pay from their taxable income. The deduction phases out for individual filers with income above $150,000 and joint filers with income above $300,000. The Joint Committee on Taxation estimates that the deduction will reduce revenues by $90 billion over the 2025 to 2034 budget period. However, that cost all occurs over the next four years, as the deduction is currently set to expire in 2028. If lawmakers choose to make the overtime tax deduction permanent, its cost would more than double to $227 billion over 10 years.
Additionally, the actual revenue loss — and therefore deficit increase — from the proposal could be even greater than current estimates, depending on the extent to which workers and employers modify their behaviors because of the new opportunity for tax savings. For example, employees might prefer taking overtime pay to receiving bonuses given the new deduction. Those changes would result in greater after-tax income for the employee. The Administration is expected to release guardrails that may limit some of these responses to the new law, but it is unclear whether they will be administrable.
Middle-Income Taxpayers Would Receive the Largest Benefits from No Tax on Overtime
According to an analysis from the Budget Lab at Yale, most of the tax benefits from no tax on overtime will go to middle-income taxpayers while providing minimal relief to those with the highest and lowest incomes. Earners in the third and fourth quintiles will receive the most substantial per household benefits, with average tax cuts of $55 and $135 per tax return in 2026. In contrast, the first and second quintile (bottom 40 percent of earners) will see virtually no tax benefit — $0 and $5 in 2026 tax savings per tax return. Households at the bottom generally don't earn overtime pay, and when they do, the tax benefits are minimal given their low taxable incomes and marginal tax rates. High-income households will see larger savings of $215 per tax return on average, but those tax savings are a smaller percentage of after-tax income (0.08 percent) compared to the change in income of the third and fourth quintiles. They also often do not qualify for overtime pay due to income-based limitations.
No Tax on Overtime Could Undermine Tax Equity
Principles of tax fairness state that taxpayers with similar total income and similar filing statuses should pay similar taxes — otherwise known as horizontal tax equity. No tax on overtime reduces horizontal tax equity, as those with similar total income may be taxed differently if they are paid in overtime. In the example below, a taxpayer regularly working five hours of overtime a week would pay 30 percent less income tax compared to a taxpayer with the same pre-tax income but who is FLSA-exempt or does not work overtime.
There are some who argue that taxing overtime pay at a lower tax rate than base wages would have the benefit of not penalizing additional work effort. As explained by the American Enterprise Institute: “Because overtime hours are a reasonable proxy for effort, exempting overtime pay from taxation could be a more efficient way to encourage work than a broader income tax cut that increases the returns to both ability and effort.” However, the AEI authors also conceded that the current definition of overtime is not a perfect proxy for effort. For example, some individuals work more than 40 hours a week but do not receive overtime pay because their hours are split between multiple jobs. The definition of overtime may also affect workers’ choices to choose overtime instead of salaried pay. As a result, AEI scholars observe that the definition of “overtime” in an overtime pay tax exclusion proposal would “have a significant impact on the budget deficit.”
Conclusion
The new deduction for overtime pay is projected to add $90 billion to our already dangerously unsustainable national debt — and could cost even more if extended beyond its current expiration date. It makes an already complex tax system even more so, creating new inequities in the tax code, as workers with identical incomes are treated differently based solely on whether they earn overtime pay. As our debt continues to rise unsustainably, lawmakers should look at both the tax and spending side of the budget ledger to find fiscally responsible reforms that improve our economic outlook going forward.
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Further Reading
The One Big Beautiful Bill Act Is the Most Expensive Reconciliation Package in Recent History
The legislative package will be the most expensive reconciliation bill in a quarter of a century and will add trillions of dollars to the U.S. debt.
Lifting the Debt Ceiling Has Been Paired with Budget Reform in the Past
Earlier this year, the United States once again hit its debt ceiling, which is currently capped at $36.1 trillion.
Even with Economic Growth Factored in, OBBBA Would Increase Deficits
The small, positive fiscal impact from slightly higher economic growth is projected to be more than offset by increased federal interest costs.