NC No Tax on Tips, Overtime Proposal

North Carolina’s House Bill 11, titled “No TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities.
on Tips, Overtime, Bonus Pay,” is gaining bipartisan traction in the General Assembly, mirroring similar proposals nationwide, including those championed by President Trump. The bill, recently advanced by the House Commerce Committee, seeks to exempt all income taxes on tips, overtime pay, and the first $2,500 of annual bonuses. While pitched as relief for low-wage service workers and hourly employees, this approach is economically distortive, poorly targeted, and risks unintended fiscal consequences.

Limited Reach, Arbitrary Benefits

HB 11 seeks to benefit tipped workers, such as waitstaff and hairstylists, and nonexempt employees under the Fair Labor Standards Act who work over 40 hours weekly. Some of these are indeed low-earners, as claimed by the proponents of the law, but the vast majority of low-income workers are not tipped workers, and not all tipped workers are low-income. Tipped workers are a small fraction of North Carolina’s labor force—approximately 125,000 out of 4.9 million employed, based on occupations where tipping is customary. Meanwhile, about 55 percent of workers could qualify for the overtime exemption, but favoring specific income types (tips, overtime, or bonuses) over others lacks a coherent policy rationale and is distributionally erratic, as many professions with overtime pay are well-compensated. Some workers would see a reduced tax burden, but others earning comparable wages with fixed hours, salaried employment, or no tips would face higher effective tax rates than tipped or overtime workers without justification.

This preferential treatment introduces distortions. Consider two North Carolinians earning $30,000 annually: Tracy, a secretary, and Bob, a waiter. Tracy earns all income as wages, while Bob earns $20,000 in wages and $10,000 in tips. Under current law, both claim the $14,600 standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes.
and owe $654 in state income tax (at the 4.25% flat rate for 2025). If HB 11 passes, Tracy’s tax liability remains $654, but Bob’s tips become exempt, reducing his taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income.
to $5,400 and his tax to $229.50—a 65 percent cut. This disparity highlights the bill’s inequity: it arbitrarily rewards some low-wage workers over others.

Tax Scenarios

Economic Distortions and Compliance Costs

Exempting specific income types incentivizes workers to seek tipped or overtime-heavy jobs, potentially pressuring employers to restructure pay—shifting to tips, bonuses, or more overtime instead of hiring additional staff. Overtime could become cheaper than new hires, as employers avoid fixed costs like benefits, or more attractive due to its tax-free status. This could crowd out job creation and complicate employment agreements, diverting resources from productive use. Worse, without safeguards, high-earners might reclassify income as “voluntary tips” to exploit the exemption, further eroding the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates.
. Even with guardrails, compliance costs would rise, undermining North Carolina’s simple flat-tax system.

Fiscal Risks: Lessons from Alabama

The full revenue impact of HB 11 remains yet unclear, with more data promised by the legislature as the bill moves forward, but Alabama’s experience with its 2023 overtime tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the Internal Revenue Service (IRS), preventing them from having to pay income tax.
(Act 2023-421) offers a cautionary tale. Initially projected to cost $34 million annually, the exemption reduced state revenue by $230 million in its first year, with a total cost of $345 million expected by its July 2025 sunset. North Carolina risks a similar miscalculation, threatening budget stability and its competitive tax climate.

Rather than carving out narrow exemptions, North Carolina could accelerate its scheduled personal income tax rate cuts—currently set to reach 3.99 percent by 2026—subject to revenue triggers. Alternatively, increasing the standard deduction would provide broad-based relief, zeroing out tax liability for the lowest earners while simplifying compliance by reducing the number of filers. These options avoid distortions, benefit all workers equitably, and align with sound tax policy principles.

Rising living costs in North Carolina demand relief, but HB 11’s targeted exemptions are not the answer. They risk undermining the state’s tax competitiveness and fiscal health. Lawmakers should prioritize efficient, neutral tax reforms—lowering rates or raising deductions—to support low-wage workers without distorting markets or budgets.