Former President Trump’s proposal to exempt all tips from federal tax would benefit few tipped workers and hurt many.
Tax-free tips might help a relatively small number of waiters at high-end restaurants. And they could reward hotel owners such as Trump by slowing efforts to raise the minimum wage for tipped workers. But many tipped workers make so little income that they already pay little or no income tax.
Trump’s idea also would create many new opportunities to game the tax system, which inevitably would result in new IRS regulations aimed at curbing tax avoidance. And a tax-exemption for tips violates every rule of tax equity. Why should a service worker avoid tax on tips while a warehouse employee earning exactly the same income must pay tax on wages?
How Much Do Tipped Workers Make?
Trump made his promise at a campaign event in Las Vegas, where nearly one-quarter of workers, or 300,000 people, are employed in the tip-heavy leisure and hospitality industry.
While he probably had hospitality workers in mind, tipped workers are employed in a wide range of occupations. Indeed, the Labor Department defines them as anyone who “customarily and regularly receive[s] more than $30 a month in tips.”
The federal minimum wage for these workers is $2.13 an hour and the basic combined hourly federal minimum wage and tip income is $7.25.
State minimum cash wages for tipped workers vary widely, from $16.28 in Washington State to $2.13 in Oklahoma. Many of these workers make so little that they will not come close to paying federal income tax under current law and thus would not benefit at all from Trump‘s proposal.
One example: Half of wait staff in the US make $32,000 or less annually, according to the Bureau of Labor Statistics. A single worker making $32,000 would owe roughly $1,900 in federal income tax. But that’s only if they could not claim benefits such as the Child Tax Credit or the Earned Income Tax Credit. Most parents making $32,000 or less who receive those credits already pay no federal income tax.
The situation for wait staff at high-end restaurants is another story. A 20% tip on a $200 meal is vastly different than one for the $9.95 special at Mom’s Diner. Indeed, the Labor Department estimates that the highest-earning 10 percent of wait staff make $60,000 or more annually. They make far more in tips than in cash wages and could benefit significantly from Trump’s plan.
The Minimum Wage Battle
But for most tipped workers, Trump’s proposal not only would not help, it might hurt.
To start, it is hard to know how customers would respond to tax-free tips, but at least some likely would reduce their gratuities.
Perhaps more important, repealing taxes on tips also could take the steam out of efforts to raise the cash minimum wage for tipped workers. Eight states and the District of Columbia have started to equalize the minimum wage for all workers. Voters have put similar initiatives on the ballot in five more states. But the lure of tax-free income could turn many workers against the shift from tips to wages.
Losing the opportunity to receive a more generous minimum wage would hurt service workers at lower-end restaurants, where tip income is relatively low. The hardest hit may be “back of the house” staff such as dish washers, who often receive only a small share of tips, enough to qualify as tipped workers but not enough to live on, or to pay taxes.
Of course, by reducing the pressure to raise the minimum wage for tipped workers, ending taxes on tips would benefit owners of restaurants and hotels such as Trump, many of whom have been aggressively fighting these efforts. See here and here.
What About Medicare and Social Security?
Another issue: While Trump said he’d repeal taxes on tipped workers, he never said which taxes. Does he mean just the federal income tax? Or does he mean Social Security and Medicare payroll taxes as well? Many low-wage workers pay more in payroll tax than in income tax, but in return for payroll tax, they get the critical Social Security and Medicare benefits. But no tax payments, no benefits.
Taxing tips never has been easy, and tips often have been a source of tax avoidance because cash tips often go unreported. However, the near-ubiquitous use of credit cards and mobile payment methods have made that less of a problem.
While tips of 15% to 20% have become common in the US, the practice remains rare in much of the developed world, where service workers are more likely to be paid a living wage.
At his Las Vegas event, Trump vowed to repeal the tip tax “right away, first thing in office.” Of course, he can’t. Only Congress can repeal federal taxes. For reasons of efficiency, fairness, and sound tax administration, let’s hope it doesn’t.
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