A UK proposal to exempt overtime pay from income tax would increase take-home pay for some workers, but the article argues that the measure would create unfairness, distort labor markets, complicate tax administration, and reduce government revenue.
Under the proposal, employees earning under £75,000 would pay no income tax on hours worked beyond a 40-hour week. The policy has been framed as a “hard work bonus” and is intended to encourage additional work while increasing workers’ disposable income.
The main criticism is that the exemption would treat workers with the same annual income differently depending on how their earnings are structured. Two people earning identical amounts could face different tax bills if one earns more through overtime and the other does not.
This creates a form of horizontal inequity because the tax system would favor workers in roles where overtime is available. It would disadvantage people who cannot access extra hours, including caregivers and workers on fixed schedules.
The proposal could also distort employer and worker behavior. Employers may have less incentive to raise base salaries if tax-free overtime becomes a way to increase take-home pay. Firms may also reorganize work to rely more on overtime instead of hiring additional staff, potentially reducing employment and encouraging excessive working hours.
The measure is also narrowly targeted at people already working substantial hours, rather than encouraging people working fewer hours to increase labor market participation.
The £75,000 eligibility threshold creates another problem. Because the exemption applies only below that level, workers crossing the threshold could face a sharp increase in their effective marginal tax rate. This could discourage additional work or income growth once a person approaches the limit.
Workers just below the threshold may also have an incentive to reclassify income as overtime to benefit from the exemption. The article identifies professionals such as lawyers and consultants as examples of groups that could potentially exploit the distinction between regular pay and overtime.
Administrative complexity is another concern. Employers and tax authorities would need to distinguish between regular earnings and overtime earnings, increasing compliance burdens and the risk of errors, avoidance, or evasion.
The fiscal cost would also be significant. Supporters argue that a full-time nurse working six overtime hours per week could save more than £1,300 per year, equal to roughly £4 per overtime hour. However, the measure is estimated to reduce government revenue by around £5 billion annually.
That revenue loss is described as equivalent to about one-fifth of the tax increases announced in the 2025 Autumn Budget. Supporters have suggested offsetting the cost through welfare spending cuts, raising concerns about distributional effects.
The article also warns that static revenue estimates may understate the true fiscal cost if employers and workers change behavior in response to the tax exemption.
A broader reform is presented as a better alternative. Instead of exempting specific categories of labor income, policymakers could lower marginal income tax rates across the board or increase tax-free allowances. These approaches would provide more uniform incentives to work while avoiding special preferences for overtime.
Broad-based tax reform is described as more neutral, simpler, and more efficient. It could improve incentives to work, increase take-home pay, support labor supply, expand the tax base, and raise economic output without creating the same distortions.
The core warning is that an overtime tax exemption may appear attractive in the short term, but it would create unequal outcomes among workers with similar incomes, distort labor market decisions, add complexity, and strain public finances while doing little to help those most in need.
Source article: taxfoundation.org
