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Speaking to a rally in June in Las Vegas, a city where a significant number of people earn tips, Donald Trump said that he would eliminate taxes on tips if he is again elected president. Democrat Kamala Harris recently jumped on the bandwagon and supported the no tax on tips pledge at her own event in Nevada, a swing state.
While it is popular, it is a bad idea, a bipartisan bad idea.
First, as many economists have pointed out, tipped income should not be taxed differently than wage income. Doing so would give employers a perverse incentive to pay tipped workers even lower wages with the expectation that they would earn more through tips that are no longer subject to income tax. In addition, employers would have an incentive to reclassify all kinds of workers as tipped workers, thereby paying them lower wages and shifting their payments to customers.
“How are we going to tell who is receiving a tip, and when that tip crosses a line into wages?” Steve Rosenthal, senior fellow at the Urban-Brookings Tax Policy Center, said recently on NPR. “How will we prevent investment bankers, say, from getting tips? And if we impose income limits, well, wouldn’t we expect low paid workers just to demand a tip rather than compensation?”
In addition, not taxing tips would give wait staff a significant financial advantage over other service industry workers, such as cooks and dishwashers, who do not typically earn tips.
Dan Beck, general manager of Moody’s Diner in Waldoboro, last week told the Bangor Daily News that the no taxes on tips plan is a “bad idea” that rewards servers who tend to make the most in a restaurant and overlooks lower-paid cooks and prep people.
“If politicians want to help a restaurant worker, they should choose not to tax back-of-the-house wages,” Beck said. “These are the employees we are desperate to hire.”
Some economists have even warned that if the no tax on tips concept became a reality, wages in industries far beyond restaurants could be reclassified as tips. That could cost the federal government $100 billion over 10 years in lost revenue just from an income tax perspective.
There would also be regional impacts as states have different minimum wages for tipped workers. The federal minimum wage for tipped workers is $2.13 an hour, with employers required to make up the difference if tips do not bring staff to at least $7.25 an hour, the federal minimum wage. Maine has far higher rates at a $7.08 tipped wage and a statewide minimum of $14.15 per hour.
If federal taxes on tipped income were eliminated, states would have to decide whether to conform with the federal policy for state taxes, likely leaving an even bigger hodgepodge of state policies.
It could add a significant new layer of complexity to state and federal tax policies. It would be made more complicated by the fact that many tipped workers don’t report cash tips for tax purposes.
Despite its economic downsides, the idea is gaining political momentum. A bipartisan bill has been introduced in the U.S. Senate and a similar bill is in the House.
If politicians really want to help low-wage workers who rely on tips, raising the minimum wage would be a big help. Harris did say she supports raising the minimum wage, in addition to pledging to eliminate taxes on tips.
Eliminating the federal income tax on tips is a costly idea that would benefit less than 3 percent of American workers. Although it is popular, candidates — including those running for president — should instead support policies that would truly help working Americans without adding layers of complexity.
