Working Overtime Is More Taxing Than You Think

March 6, 1997 • Commentary
By George Nastas III and Stephen Moore

Later this year, as you’re taking a break from all of your hard work, you might want to ask yourself if the extra hours on the job are worth it. In these times of stagnant wages, more and more Americans are increasing their income by working longer hours. The Labor Department says that Americans have been putting in longer workweeks in recent years. Thanks to strong product demand, many companies are paying record amounts of overtime. For workers, that usually means time and a half or, in some cases, double pay.

The payoff for overtime work appears to be a very good deal for the employee. But here’s some unpleasant news. Thanks to the rising burden of taxes, the bonus income actually received from working longer hours is much less than one might think. That is because every extra hour worked is taxed at the worker’s highest marginal tax rate. In some cases, overtime work may even push the worker into a higher tax bracket.

It turns out that even if the worker receives time and a half for overtime, a surprisingly large share of the bonus wages goes straight to the tax collector.

Take as an example a single working mother who is a nurse working at the community hospital. Assume her annual income is $40,000. Her job pays her a wage of about $20 per hour. As do most middle‐​income single heads of households, she struggles to make ends meet and pay the monthly bills. Now assume that her boss asks her on Friday if she wants to come in on Saturday, work eight hours of overtime, and earn time and a half. Sounds at first like a great deal. She calculates in her head that she will earn $30 per hour. That will net her $240 to pay the bills mounting up at home. Right?

Wrong. Her net pay, after taxes, will be much lower. On her overtime earnings, she will have to pay a 28 percent federal income tax, a 7.65 percent federal payroll tax, and roughly a 6 percent state income tax (assuming she lives in an average‐​tax state). In addition, her employer must pay a 7.65 percent payroll tax on her behalf. Let’s calculate how all of those taxes will affect her take‐​home pay.

The table shows that her $240 gross pay shrinks to $144 in take‐​home pay. Including the payroll taxes paid by her employer, the government nets $114 on the deal. That includes $63 in federal income taxes, $14 in state income taxes, and $37 in employer‐ and employee‐​paid payroll taxes. In other words, the tax collector gets about 45 percent of the total compensation for the woman’s extra work effort.

The Government’s Take
Overtime Pay $240.00
Federal Income Tax $63.20
State Income Tax $14.40
Employee‐​Paid Payroll Tax $18.40
Total Employee Taxes $96.00
Employer Payroll Tax $18.40
Worker’s Take‐​Home Pay $144.00
Government’s Take 114.40

The actual hourly take‐​home pay for giving up her Saturday is not $30 per hour, it’s closer to $18 an hour. Or to put it another way, of the eight hours she works on Saturday, three and a half go to paying taxes.

In high‐​tax states and cities, such as New York, California, and Washington, D.C., the disincentive to work overtime is even more pronounced. In those and other high‐​tax jurisdictions the state‐​local tax rate reaches above 10 percent. So, almost half of a worker’s overtime earnings can be swallowed up by government. (And of course, this analysis does not include the many other taxes imposed by government, such as corporate taxes, sales taxes, excise taxes, property taxes, fees, and other charges.)

In 1993, for example, the average American worker put in an estimated four hours of overtime a week. One conclusion to draw from the above analysis is that Uncle Sam is drawing a huge revenue windfall, well into the billions of dollars from all of that overtime work. It is noteworthy that the government gets much more tax revenue from an hour of overtime worked by an existing employee than from an hour of work by a new hire. That is true for several reasons. First, the overtime pay rate is higher. Second, a new hire gets deductions and credits from the first dollars earned, which reduce the average tax rate. Third, the first $25,000 or so of income of a new worker is taxed at a 15 percent rate, whereas a worker who makes over $30,000 a year and works extra hours is taxed at the 28 percent rate on all overtime income.

We’re not suggesting that the members of Congress thought of this revenue windfall when they erected all the existing barriers to hiring new workers, such as employer mandates. But it is interesting that government profits from its own anti‐​employment policies.

The next time your boss asks you to work overtime, you might want to tell him that, thanks to Uncle Sam, the extra effort is just too taxing.

About the Authors
George Nastas III