Here’s a Tip: “No taxes on tips” may be good politics, but is bad policy
It’s not a new idea: A dozen years ago, Republican presidential candidate Ron Paul proposed it in the same city. It’s not new: Ron Paul, a Republican presidential candidate, proposed the idea in the same city a dozen years ago.
But this bipartisan proposal to “no tax on tips” is the most prominent instance of a politically appealing soundbite trump sound policy. (Trump recently raised the issue of excluding overtime pay from taxes, but Harris rejected it. )
Don’t get me wrong. Attention should be paid to low-wage workers and tipped employees. Their incomes are subject to wide fluctuations, and they can be thrown into economic ruin by a child’s illness or a broken-down vehicle. As my TPC colleague Howard Gleckman noted, encouraging tips can worsen their financial problems, substituting unpredictable generousness for steady wages. TPC estimates that over 40 percent of these workers won’t benefit from the exemption, as they don’t pay income taxes. If Trump wants to withhold no Social Security tax from tips, then his plan could threaten retirement security for tipped workers. I spent years on Capitol Hill helping to create tax rules that would advance economic and social goals. In the decades following in private practice, I advised clients how to use tax rules effectively.
These experiences taught me that Congress’s best-laid tax plans too often go awry.
In tax policies, we evaluate reforms based on how well they promote efficiency, equity, and revenue. “No taxes on tipping” fails to meet all three criteria because it favors certain taxpayers and not others in a similar situation, distorts compensation arrangements and labor market, and loses substantial revenue – potentially hundreds of millions of dollars over the first decade.
Favoring a particular economic sector or geographic area in compensation makes little sense. It’s unfair to give tax-free tips to McDonald’s customer service agents but not Le Cirque’s waiters. Or to favor a housekeeper at a hotel, but not the house cleaner of a homeowner. Or, in the gig economy, it would be better to favor traditional employees over independent contractors.
Tax-free tips would also distort the compensation arrangements and labor market. Non-tipped employees, such as landscapers and plumbers, auto mechanics and grocery tellers, could start to demand tips. Or they could leave their jobs to work for tipped employers. This could result in a surplus of restaurant waiters and a shortage of fast-food cashiers, abundance of bartenders and not enough warehouse workers, or too many food deliverers and too few package deliverers.
Meanwhile, consumers frustrated already by the recent explosion of tip requests might find many more payment pads with tip instructions thrust at them when time comes to settle up. If discretionary tips replace fixed wages, then the labor market would be less transparent, less certain, and less efficient.
Very few tax rules fully and consistently align public and private objectives. When Congress drafts tax laws, it often helps those they want to help and misses those they don’t. These misfires can have small but sometimes large consequences, such as when the taxation on tips is ended. This could encourage millions of workers, like in the case of the tip tax, to game the system. There are many ways to help low-wage workers, including raising the minimum wage and eliminating the sub-minimum wages for tipped employees.
Maybe the proposals of Trump and Harris will expire along with their campaigns just as Ron Paul’s did. Let’s hope that what happens in Vegas doesn’t affect tax policy.
