On the campaign trail, President Donald Trump aimed to attract working-class voters in pivotal swing states by promising to exempt tips and overtime pay from federal income taxes. Now, Congress is edging closer to fulfilling this promise, despite ongoing concerns about the implications for the federal deficit and potential disruptions in the labor market. Both tax exemption measures still face significant challenges as House leadership works diligently to secure the necessary votes to pass a budget that includes these tax incentives before it is sent to the Senate.
A separate bill that aims to exempt tips, but not overtime, from federal income taxes has already gained unanimous approval in the Senate and is awaiting action in the House. These tax breaks, initially proposed by Trump during his campaign, have fostered an unusual coalition of support that transcends typical partisan divides. Unions, including the Teamsters, and industry groups like the National Restaurant Association, are advocating for these tax exemptions alongside some Democrats.
However, conservative think tanks and economists have voiced concerns regarding the impact of these exemptions on the federal deficit and the labor market. Initially, several influential Republicans expressed skepticism about the proposal, citing rising national debt and questioning its fairness to employees who do not receive tips. Nevertheless, with Trump now in the White House, these tax exemptions could serve as a compelling selling point for congressional Republicans aiming to appeal to working-class voters in a broader budget bill that also includes benefits for corporations and higher-income households.
Public opinion appears to lean favorably toward eliminating taxes on tips, with approximately 75% of voters across party lines supporting the initiative, according to a recent Ipsos poll. Sarah Chamberlain, head of the Republican Main Street Partnership, a moderate Republican group, noted, “The working class has left the Democrats and come over to the Republican Party, especially with Trump. That’s who he appeals to — so it feeds the constituency of a lot of our members, and frankly, it’s just really a good idea.”
While many Democrats have supported the tax exemptions, including Sen. Jacky Rosen from Nevada, the party plans to highlight potential cuts in other areas of the Republican budget that could negatively impact the same workers benefiting from the tax cuts, such as reductions to Medicaid and food stamps. Democratic strategist Martha McKenna criticized the duality of giving a tax cut to tipped workers while simultaneously slashing essential services, stating, “They are giving tipped workers a small break and then punching them in the face with these health care cuts.”
Economists have indicated that while some workers would experience notable increases in their after-tax income, the broader economic impact would be relatively limited. Tipped workers constitute about 2.5% of the workforce, and around 12% of hourly workers receive overtime pay annually, according to an analysis by the Yale Budget Lab. Notably, as many as 40% of tipped workers do not earn enough to owe federal income tax on their earnings.
Ernie Tedeschi, director of economics at the Yale Budget Lab, explained, “This is really a narrow segment of the labor force that is going to see any benefit at all from this — but that does limit its cost. I think a big reason why Congress is embracing it is because this is one of the lower-cost ideas, and it’s a very high-profile win. You can say that you are helping low-wage workers, even if it’s not that many workers.”
The proposed tax exemption would only apply to federal income tax, meaning that workers would still be responsible for paying Social Security and Medicare taxes, in addition to any state or local taxes. Both tax exemptions are designed as deductions that workers would claim when filing their taxes the following year. Consequently, employers would continue to withhold taxes on tips or overtime through regular paychecks, but the income would be deductible from the workers’ final tax bills when they file their annual returns.
These overtime exemptions could provide significant benefits to workers in various sectors, including manufacturing, mining, construction, and public safety. The International Association of Fire Fighters has expressed support for the measure, emphasizing the burden of overtime hours on their members due to staffing shortages. Edward Kelly, the association's general president, stated, “Fire fighters already work 53 hours a week before even qualifying for overtime pay. The proposal to eliminate taxes on overtime would bring meaningful relief to fire fighters, helping them keep more of what they earn while working long hours to keep their communities safe.”
Both the House and Senate bills include limitations on tip exemptions aimed at preventing employers from manipulating the system. These provisions would make it harder for employers to shift hourly or salaried workers to tip-based compensation, exclude higher-income earners making over $160,000, and cap the amount of tips that could be deducted from a tax return at $25,000. Alex Muresianu, a senior policy analyst at the Tax Foundation, commented on the budgetary implications, stating, “I think the worst-case scenario from a budgetary cost perspective has been averted by limiting it to traditionally tipped industries and excluding highly compensated employees.”
Despite these limitations, the measures would still incur substantial costs to the federal budget. The exemption for overtime in the House budget bill is projected to result in $124 billion in lost tax revenue, while the tip tax break could reduce tax collections by $40 billion, according to the Congressional Budget Office. Under current legislation, these tax breaks would expire in 2028, potentially prompting political pressure to extend them amid that year’s presidential election.
The implications for the federal deficit could escalate if the exemptions are extended beyond their initial expiration date. Brett Loper, executive vice president of policy for the Peter G. Peterson Foundation, warned, “You’re making it more challenging for a more limited base to raise revenue, and from our perspective, the gaping hole that you have between revenues and spending is creating sustained deficits.” He added, “You’re accelerating the amount of our national debt, which we think is going to have severe long-term economic consequences.”
Critics have also raised concerns that the exemptions would create an uneven distribution of the tax burden, disadvantaging certain workers. For instance, a worker earning an hourly wage, such as a janitor, may face a higher tax bill than a bartender in the same restaurant, leading to disparities among workers. Furthermore, reducing taxes on overtime could incentivize more employees to accept overtime hours, potentially resulting in fewer overall job opportunities in certain sectors if employers can maximize hours from their existing workforce. Tedeschi noted, “Workers get a tax benefit, but over time, employers are going to pay a little bit less than they otherwise would have in wages to these workers.”
