Alabama Expands tax-free overtime, Should it repeal the exemption?
Before Donald Trump, the president-elect, proposed it on the federal level in November 2023, Alabama passed a tax exemption law for overtime wages. Act 2023-421, also known as H.B. 217) exempted any amounts received by a full-time, hourly wage employee for work performed above 40 hours a week from state income taxes starting January 1, 2024.0 217) excluded any amounts received by a full-time, hourly wage employee as compensation for work performed above 40 hours a week from state income taxes, starting January 1, 2024.
While similar measures were proposed by North Carolina and South Carolina earlier, Alabama is the first and so far only state to adopt an overtime exemption, which was intended to compensate lower-income wage earners for inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck will cover less goods, bills, and services. It is sometimes called a “hidden” tax, as it makes taxpayers less wealthy due to increased costs and “bracket-creep”, while increasing government spending power.
, and the COVID shut-down caused income losses. The state legislature recently passed an amendment that expanded eligibility for some full-time salary workers who are eligible for overtime pay under Fair Labor Standards Act. (FLSA), effective October 1, 2024. The US Department of Labor announced that, as of July 1, 2024 the FLSA threshold for overtime pay is $43,888. This figure will increase to $58,656 in January 2025. The amendment, Act 2024-437, U.S. Fair Labor Standards Alignment clarifies what is exempted from Alabama’s income tax. Advocates for hourly workers claimed previously that bonuses, incentives, and commissions paid over and above 40-hour wages would qualify. As a state response to these questions and uncertainties, the new amendment aligns state exemption definitions of “overtime”. This change will allow for exempt overtime pay to be calculated according to the FLSA. The FLSA is a federal overtime regulation that all states including Alabama must follow. Federal law stipulates that, unless an employee is exempt from overtime pay, all hours over 40 in a given week must be compensated at a rate of at least 1.5 times the regular rate. Some employers supplement this with holiday pay, if applicable. In Alabama, the extra pay is now
tax. A tax is a mandatory payment collected by local, national, and state governments to cover costs of government services, goods, or activities.
The state legislature can extend the exemption past that date. However, it is probably best to let it expire. These arbitrary exemptions, which are aimed at lower-income workers, may seem like a good idea, but they increase compliance costs and create distortions in the labor market. They create an incentive for employees to look for hourly or non-exempt jobs, and existing employees who qualify for overtime would seek more hours.
Additional overtime hours for existing employees could crowd out the hiring of additional employees, either by making overtime labor cheaper (employers could potentially pay less) or by increasing the return on the marginal labor (because it is untaxed). Employers may also be forced to change their policies on overtime or find themselves in a position where they need to limit it. Instead of putting time and effort to productive use, it would be wasted on negotiating agreements. The law does benefit some employees, and in theory should also increase labor supply (from current employees), but the resources wasted in compliance and inefficiency reduces these gains. A better way to achieve the same positive supply shock would be to decrease the overall income tax rate and do away with all such distortionary and arbitrary exemptions.At present, the policy penalizes workers who earn a salary marginally above the overtime threshold or are not otherwise able to work overtime. Retail and services sector workers receive a tax exemption, whereas workers in office environments with fixed schedules are subject to higher average tax rates without any good policy justification. A neutral tax system is one that does not favor any particular sector. The overtime exemption is not a good model, as it complicates the code, reduces neutrality and increases compliance and reporting costs. Lawmakers would be wise to let it expire this coming June.Stay informed on the tax policies impacting you.
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