Donald Trump’s “No Tax on Tips” policy initially came across as an economic relief for service workers, but policy actions have the effect of generating unintended outcomes. Implemented, the policy would bring economic distortions, changes in labor markets, and ultimately displease the majority of employees anticipating benefit from it.
Unfair Advantages
Rendering gratuities tax-exempt creates imbalances. An in-server earning the same amount as a back-of-house cook in a Manhattan restaurant wouldn’t have relief from taxation, while the in-server would. Similarly, exclusion of overtime pay advantages some highly paid union workers to the detriment of much part-time and multi-job labor force. Rather than creating equity, such exceptions can only heighten existing inequalities.
Loopholes and Manipulation
When tax policies differ across kinds of income, individuals and businesses learn how to exploit them. Employers may claim more wages as tips to reduce tax payments, and even high-income individuals may reclassify income as gratuities. Unless there are strict caps, the wealthy can gain more from such policies than workers. History offers cautionary anecdotes: a 1990 luxury tax targeting the rich murdered thousands of working-class jobs in the boat industry. The 17th-century British “window tax” prompted landlords to brick up their windows, disfiguring the poor. A policy of untaxed tips could have similarly unforeseen consequences.
Bureaucratic Complication
Tax-free tips would have to be closely tracked. Workers would have to prove eligibility, which would create additional paperwork and IRS scrutiny. Electronic payments already make tip underreporting difficult, and a policy shift could result in more enforcement, not relief. In addition, if tips are exempt from taxation, companies can reduce base pay or require longer work hours. Likewise, declaring overtime as tax-free may encourage employers to work current staff beyond their limits instead of employing more workers, at their expense.
Revenue Loss and Consumer Reaction
Tax breaks come at a cost. Estimates suggest “No Tax on Overtime” could cost $673 billion over a decade, with “No Tax on Tips” adding $78 billion. The revenue loss might lead to higher taxes elsewhere, budget cuts, or more deficit spending. Moreover, consumers tip partially because they believe that employees depend on gratuities. If tipped workers are perceived as getting a tax advantage that they themselves don’t receive, tipping patterns might change. More irritation with electronic payment tipping encourages already suggests that consumers are in revolt.
Although “No Tax on Tips” appears to be a triumph for service workers, the reality is not quite so black and white. The policy promises to exacerbate inequalities, encourage tax evasion, make enforcement difficult, and fail to provide meaningful relief. If history is any guide, well-meaning tax relief policies are more likely to hurt than help.
