Plans to stop taxing tips sound better than they really are

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We’ve found one thing presidential candidates Kamala Harris and Donald Trump agree on: tips should no longer be subject to federal income taxes. But this seemingly worker-friendly change (which would likely require congressional approval) could have major unintended consequences.

For starters, the Committee for a Responsible Federal Budget (a nonpartisan nonprofit) reports that Harris’ plan could add anywhere from $100 billion to $200 billion to the federal budget deficit over 10 years. The organization scores Trump’s plan even worse, estimating it would add $150 billion to $250 billion to the deficit over the next decade. Taxes and fees are often like Whac-A-Mole: when one goes down, another pops up.

Americans are tired of tipping

I fear these plans could make American workers even more reliant on tips at a time when many customers are fed up with the practice. About 6 in 10 U.S. adults (59 percent) have at least one negative view toward tipping, according to a recent Bankrate survey. That includes 37 percent who believe businesses should pay their employees better rather than relying so much on tips, 35 percent who believe that tipping culture has gotten out of control and 34 percent who are annoyed about pre-entered tip screens (which have become common at coffee shops, food trucks and elsewhere).

Eliminating taxes on tips could make the situation worse. It’s certainly not going to incentivize businesses to pay their workers more money. In fact, it’s easy to envision employers classifying more employees as “tipped workers” under the guise of a “no tax on tips” policy. That’s potentially a precarious place to be, since the federal tipped minimum wage is a mere $2.13 per hour (unchanged since 1991).

Some municipalities have higher minimum wages for tipped workers, but making a living on tips has become increasingly tenuous. While there was briefly a groundswell of support for service-industry workers in 2020 amidst the COVID-19 pandemic, Americans have tipped much less frequently in the years since.

• For example, 75 percent of sit-down restaurant diners always tipped in 2021. Now it’s 67 percent.
• 63 percent always tipped their barber/hair stylist in 2021. That has fallen to 55 percent.
• 59 percent always tipped for food delivery in 2021, compared with 51 percent today.
• 48 percent always tipped their taxi/rideshare drivers in 2021, versus 41 percent at present.

The generational breakouts are particularly stark. Only 35 percent of Gen Zers (ages 18-27) who go to sit-down restaurants always leave a tip. That increases to a still-low 56 percent among millennial diners (ages 28-43). Tipping is more customary among Gen Xers (78 percent of these 44-59 year-olds always tip at sit-down restaurants) and baby boomers (ages 60-78; 86 percent always tip when they go to sit-down restaurants). With young adults, in particular, tipping so infrequently, working-class employees would be better off relying less on tips.

Could the rich take advantage?

Highly-paid professionals could seek to take advantage of tax-free tips. Could an executive’s multimillion-dollar bonus be classified as a tip so as to avoid federal taxes? At scale, that could substantially add to the budget deficit and would not help the blue-collar individuals this idea is supposed to support. Vice President Harris has signaled a desire for income limits on tax-free tips; former President Trump’s plan is less clear.

Plus, many tipped workers aren’t paying taxes anyway

Cash tips are notoriously underreported, although expanded credit and debit card usage is providing the IRS with more of a paper trail. Even then, “37 percent of tipped workers had incomes low enough that they faced no federal income tax in 2022, even before accounting for tax credits,” according to the Yale Budget Lab.

Working without a safety net

Employees and independent contractors who rely heavily on tips are at the whims of their customers. If business is slow or customers are stingy, their income suffers. And these types of workers are less likely to receive paid time off, health insurance benefits, 401(k) matches and other perks. Take gig workers, for example. While it sounds nice to be your own boss and set your own hours, there’s a fragility associated with the lack of a safety net.

The bottom line

Eliminating federal taxes on tips is a provocative campaign talking point – it’s not a coincidence that both candidates debuted their ideas in tourism-heavy Nevada – but it lacks substance. To truly improve workers’ lives, politicians should focus on boosting wages and benefits rather than doubling down on a tipping-centric culture that’s already falling out of favor.

Have a question about credit cards? E-mail me at ted.rossman@bankrate.com and I’d be happy to help.