Why Reform’s tax-free overtime plan is a bad idea

Reform’s proposed tax break on overtime is likely to feature prominently in the Makerfield pitch. But it is also yet another example of a policy that is both good politics and terrible economics.

The Reform party is proposing that people who earn less than £75,000 and work overtime above a 40-hour week will pay no income tax on the extra hours. It is always refreshing to hear any talk of tax cuts. Unfortunately, this idea has many flaws.

Specifically, Reform would “institute a new UK-wide uncapped personal allowance for overtime above a 40-hour working week for those earning less than £75,000“.

Nigel Farage said the overtime proposals would “finally make work pay, drive up productivity and restore the appeal of a strong work culture“.

He added that hardworking people “look around and see that work simply doesn’t pay, that benefits often match or beat what they earn, and that ordinary families are being dragged into higher tax bands with nothing to show for it”.

To be clear, this is a well-intentioned proposal. The problem is that the planned tax break would be unfair, complex, and have many unintended and unwelcome consequences. There are also lots of much better ways to “make work pay”.

Let’s start with the claims around “fairness”.

Supporters of the Reform proposal have picked out nurses, ambulance staff, police, and fire officers as likely winners. However, emergency workers are already paid more for extra hours (typically 1.3-1.5 times the basic rate, sometimes two times). No-one begrudges them that, but the point is that overtime working is already rewarded at a higher rate. And of course, many private sector employers pay higher rates for overtime working too.

However, Reform’s proposal would not benefit the self-employed, those who work multiple jobs, or those who are not paid by the hour. The 40-hour threshold means that someone working part-time (say 20 hours a week) who does an extra shift to make ends meet would not benefit either. This would not be “fair” or “fairer”.

Reform’s proposal would also add even more complexity to the tax system. This is never good, but in this case, it could create lots more opportunities to avoid tax. For example, what is to stop workers and employers from agreeing to cut (or freeze) regular pay and only increase overtime pay instead?

This leads on to some of the other unintended consequences.

Nigel Farage suggests this policy would “drive up productivity and restore the appeal of a strong work culture”. It is not clear how. On productivity, output per worker might increase, but not output per hour worked, which is what really matters.

Moreover, a “strong work culture” could just mean a “long hours culture”, again not obviously a “good thing”. More people are also likely to move to hourly contracts, especially in jobs where overtime is less common. This could replace flexible working with a “clock-punching” culture.

Some firms might spread the same total amount of hours among a smaller number of workers, meaning some lose their jobs. And if overtime is taxed at a lower rate, firms might just reduce pre-tax pay, leaving workers no better off.

The Trump administration has introduced similar schemes in the US, covering both overtime and tips. These are already proving to be difficult to administer, as well as backfiring in other ways.

For example, some US firms are offering more hours at lower pre-tax rates, rather than boosting pay across the board. And the hospitality sector has seen an even more aggressively enforced tipping policy, as basic pay is held down.

Here it is worth reading these blogs from two US-based think tanks (neither of which could be described as “left wing”):

“No Tax on Tips and Overtime: A Case Study in How the Tax Code Gets More Complicated”, published by the Cato Institute

“No Tax on Tips and Overtime Proposals Gain Steam Across States, but Remain a Bad Idea”, published by the Tax Foundation

France has also tried exempting overtime from tax, with (predictably) disappointing results. The conclusions of the leading study were that the scheme introduced in 2007 “had no significant impact on hours worked” and that “it induced workers and employers to manipulate the overtime hours they declare in order to optimise their tax situation.”

In other words, some people (mainly the already better off) were able to game the system, but there was little benefit for others - or for the French economy as a whole.

Finally, Reform estimates that this tax break would cost £5 billion. I have not checked that figure, but it is not difficult to think of better ways of using £5 billion to tackle the problems that the party correctly identifies.

More sensible alternatives might include reducing taxes on all jobs, especially employers’ National Insurance, merging income tax and NI, unfreezing personal allowances, and removing other punitive marginal tax rates and cliff edges instead of creating a new one. All these options would be fairer, simpler, and less distortionary.

ps. (added 25 May) Dan Neidle and his team at Tax Policy Associates have now produced an excellent briefing on Reform’s proposal. I think I agree with every word!