Affordability, a defining issue for the 2026 midterms, has lawmakers in both parties racing to show voters they are doing something about reducing the cost of living. This week President Trump highlighted tips and overtime deductions as part of that effort. But newly released TPC estimates show “no tax on tips” and “no tax on overtime” deductions enacted in last year’s One Big Beautiful Bill Act (OBBBA) provide only modest tax relief to a relatively small share of taxpayers at significant cost.
TPC finds that only 3 percent of taxpayers benefit from tips deductions and 10 percent from the overtime deduction. Although both deductions are scheduled to expire in 2028, their political popularity could create pressure to extend them. Doing so through 2036 would cost an additional $260 billion according to TPC.
Fortunately, better alternatives to improving affordability are available. A targeted expansion of the Earned Income Tax Credit (EITC) would reach a broader and lower-income population more directly and could be paired with training to help workers displaced by AI.
Rules and underreporting limit the deductions’ reach
Both tips and overtime deductions have complicated rules that create compliance risks. To claim the deduction for voluntarily provided tips, a worker must determine whether their occupation is one “that customarily and regularly received tips on or before Dec. 31, 2024” and whether their employer’s business qualifies under the law. Not all tipped income and occupations qualify, limiting the deduction’s reach and adding complexity.
Perhaps most importantly, the deduction only applies to officially reported tips. For example, workers might interpret “no tax on tips” as “tips don't need to be reported.” They could forgo the deduction and contribute to an already pervasive underreporting problem. Total reported tips averaged $24.2 billion per year over 2005 to 2018 for full-service restaurants alone, and the IRS estimates that only about 45 percent of tips are reported on tax filings.
Identifying and reporting qualifying overtime pay presents another source of uncertainty. The overtime deduction applies only to the premium pay earned from working overtime hours, not the worker’s full overtime wages. For example, a worker earning $20 an hour in base pay who works 10 overtime hours at time and a half ($30 an hour) receives $300 in overtime pay, but can deduct only $100 in premium pay. Because the Bureau of Labor Statistics’ National Compensation Survey does not separately identify the Fair Labor Standards Act (FLSA) premium portion, the OBBBA provision’s effects are harder to estimate.
The stated goal of both deductions is to provide relief to working Americans in service and hourly jobs. Yet TPC estimates that only 3 percent of taxpayers will benefit from the tipped income deduction, with an average reduction in tax liability of $1,400 among those who benefit. The overtime deduction will benefit 10 percent of households, with an average benefit of $1,200. More than 90 percent of low-income workers in the bottom 40 percent of the distribution will not benefit from either deduction, in part because many already owe little or no federal income tax after the standard deduction and applicable credits.
Congress has broader alternatives to support working Americans
If Congress’s goal is immediate financial support, an equivalent amount spent on a targeted expansion of the earned income tax credit (EITC) would reach a broader and lower-income population more directly. The federal EITC currently delivers about $70 billion annually to 24 million working families and lifted an estimated 4.3 million people above the poverty line in 2024. The American Rescue Plan's temporary EITC expansion for workers without children increased after-tax income and reduced material hardship for more than 17 million low-income workers at a cost of roughly $13 billion per year.
If Congress’s goal is to prepare workers for technological change, it could redirect some of the cost of extending the tips and overtime deductions toward reinventing worker training for an AI-driven economy. Even a portion of the deductions’ roughly $30 billion annual cost could substantially expand access to "upskilling," helping low-wage workers develop new or more advanced skills. That investment could be spread over several years and should not rely solely on existing federal training programs, which have long been underfunded.
As AI reshapes jobs and increases the risk of worker displacement, training should focus not only on helping workers transition to new occupations, but also on helping them learn to work with AI and new technologies so they can adapt and remain productive in their existing jobs. Targeted apprenticeships and employer-led training programs could help workers build these skills and improve longer-term economic mobility, rather than simply reducing their tax bills today.
Given the country's fiscal outlook and the uncertainty surrounding AI-driven job displacement, affordability will be an ongoing concern, and tax and overtime deductions aren’t addressing the problem for most Americans. A targeted EITC expansion would provide broader immediate support, while worker training could help people prepare for the lasting changes AI will bring to the workplace. Congress could weigh those alternatives before committing another $260 billion to extending the temporary deductions for tips and overtime.
