As lawmakers speed toward extending expiring provisions from the Tax Cuts and Jobs Act (TCJA), they should watch out for tax policy potholes. Proposals to eliminate taxes on tips, overtime pay, and some Social Security benefits may seem like the road to relief, but these gimmicks would cause more harm than good for taxpayers and businesses. Instead of creating a patchier tax code with some winners and many more losers, lawmakers must simplify the tax code and ensure shared prosperity.
Getting rid of taxes on tips is a cliche idea that gained bipartisan traction in the lead-up to the 2024 Presidential Election. Advocates argue that the policy would be a driver of economic activity and benefit low-income workers. The reality is it would further distort the tax code and warp economic activity based on hollow political appeals. There’s simply no principle or reason why a teacher making $70,000 a year should pay more in taxes than a server making $80,000 in hourly wages and tips. No educator should have to choose between her students and gaining tax perks from picking a politically-favored profession. Employees wouldn’t be the only ones facing tough tradeoffs. Industries would likely respond to this new tax policy by pivoting compensation to tipping, making the policy even more problematic and resulting in less stable compensation.
Repealing the tax on overtime pay presents similar problems. As it stands, overtime pay for workers clocking in more than 40 hours per week faces the same tax treatment as ordinary pay. Ending this simple and fair status-quo would significantly shift incentives for companies and their employees, and not for the better. As the Tax Foundation’s Garrett Watson and Erica York note, "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." Decisions such as whether to take overtime and what kind of jobs to take should be up to workers, not meddling tax bureaucrats.
Abolishing taxes on Social Security benefits is yet another proposal that would further mangle the tax code. Currently, individuals who make less than $25,000 (and married joint filers earning less than $32,000) do not pay tax on Social Security benefits. Already, “About half of Social Security beneficiaries pay no tax on their benefits — primarily because their incomes fall below the specified thresholds,” writes Paul N. Van de Water, a senior fellow at the Center on Budget and Policy Priorities. Exempting the other half of the beneficiary population would put Social Security benefits on a tax policy pedestal compared to other forms of retirement income, such as distributions from retirement accounts and annuities. Privately-funded retirement accounts play a growing role in funding Americans’ retirements and deserve a level-playing field with a debt-fueled and taxpayer-funded system.
Moreover, the addition of these provisions in the tax code present deficit reduction issues. The removal of the tax on social security could increase costs by $1.5 trillion over the next 10 years. The elimination of the tax on overtime and tax on tips could cause a deficit increase of of $866 billion and another $107 billion over the same time period. Fiscal responsibility should be a part of lawmakers approach to tax reform.
Lawmakers would be wise to avoid tax policy potholes, which would only benefit small numbers of taxpayers at everyone else’s expense. There is simply no reason that income from tips, overtime, or Social Security is more worthy of exemption than any other kind of income. Instead, Congress should focus on alternatives that simplify the tax code and provide broad-based tax relief to individuals and businesses. A permanent extension of TCJA is of paramount importance. Lawmakers need to quit tooting their own horns on gimmicky tax proposals and prioritize sensible, fair, and pro-growth tax reform. Special treatment for tips, overtime pay, and Social Security benefits accomplishes the opposite at a significant cost.
