Experts warn Trump and Harris "no tax on tips" proposals would invite serious "gaming" of the system

Vice President Kamala Harris and former President Donald Trump have both proposed axing taxes on tips as they ramp up their presidential bids. But, even if the idea sounds appealing in theory, tax experts say a policy making tips tax-free wouldn't be all that helpful to workers in tipped occupations in practice.

Neither of the two major-party candidates have detailed their visions for the tax-free tip proposals, which would first have to be approved by Congress. Their suggestions have also raised questions around whether and to what extent guardrails against fraud and abuse would be implemented and how much tipped income would go untaxed, according to CNN.

Despite the lack of details, the proposed idea "shows the lack of seriousness of both campaigns on tax policy because no tax on tips is an idea with narrow political appeal but no policy rationale," Erica York, the research director of think tank the Tax Foundation, told Salon.

"Depending on how it’s designed, an exemption or exclusion could interact with other parts of the existing tax system, like qualification for refundable tax credits and Social Security benefits, and it could invite significant gaming as other workers and industries try to benefit from the policy too," she said.

Trump has campaigned on the "no tax on tips" policy since June, according to NPR, after a server in Las Vegas lamented the portion of her tipped wages the government was taking in taxes.

Harris joined Trump in boosting the policy at a campaign rally in Nevada last weekend, touting a tax elimination on tips "for service and hospitality workers" alongside a promise to raise the federal minimum wage. A Harris campaign official told CNN that her plan would include an income limit and work to bar hedge fund managers and lawyers from attempting to exploit the policy in their compensation practices. Under Harris' proposal, tips would also still be subject to payroll taxes.

On Tuesday, the former president expressed an interest in nixing federal income and payroll taxes from tips, noting that his proposal would do "the bore" and cover both matters in an interview with Spectrum News 1 in North Carolina.

Not long after Trump's June promise to eliminate taxes on tips, Sen. Ted Cruz, R-Texas, introduced the "No Tax on Tips Act," a bill that would allow workers to deduct tips paid in cash, check or by credit and debit cards on their federal income taxes. Cruz's proposal, which has received Democratic support, does not cut federal payroll taxes, which are used to fund Social Security and Medicare.

Though these "no tax on tip" policies appear to be framed around helping low-wage workers, they're not "particularly effective" at doing so, according to Ernie Tedeschi, the economic director of policy research center The Budget Lab at Yale University.

"That's because tipped occupations are not a big share of the U.S. labor force," Tedeschi, who's also the former chief economist at the White House Council of Economic Advisers, told Salon, emphasizing that raising the minimum wage would be a more effective way to help low-income workers. "By limiting this benefit to just tipped occupations," he added, "you are necessarily only focusing on a very narrow slice of workers in America right now."

People who work in tipped occupations account for just 2.5 percent of all employment, according to the Budget Lab. Those hospitality and service workers include bartenders, food delivery workers, hotel staffers and waiters among others.

The current federal tipped minimum wage sits at $2.13 per hour with a requirement that employees must make at least the federal minimum wage of $7.25 an hour, meaning employers have to cover the difference if tips don't. A number of states and municipalities, according to CNN, have higher minimum wages and minimum tipped wages, while some states have eliminated lower wages for tipped workers altogether.

According to the Budget Lab, workers in tipped occupations are typically younger and receive lower pay, with their typical 2023 weekly wage amounting to $538 — including tips — compared to the typical $1,000 non-tipped workers made each week. As a result, many of those workers don't earn enough to owe federal income taxes.

"No tax on tips" policies also wouldn't assist low- and moderate-wage workers much either. The Budget Lab found that only 5 percent of workers making less than $17.66 an hour are in tipped occupations.

With this proposed policy, "it's not only a narrow slice of of the labor force that's being helped, but even within that narrow slice, more than a third of those workers just wouldn't be helped at the outset because they pay no federal income tax," Tedeschi said.

York added that the policy would "fail on neutrality grounds" in how it favored some workers over others. A cashier who earns all her income as wages and a waitress who earns her income through a combination of wages and tips tend to make around the same amount of money, she explained. But under this policy "one would benefit while another wouldn't."

"There’s no reason to target tax cuts to only some types of workers," she said, arguing that such a policy "would also invite significant gaming, and implementing guardrails to discourage that type of behavior would increase the administrative burden on the IRS to enforce."

The behavioral response of employees, employers and customers to cutting taxes on tips also remains uncertain and dependent on the design of the policy. Employers "love this idea" because it will likely increase demand for tipped jobs, which provide them with "a little bit more leeway to pay workers a little bit less in wages than they would otherwise," shifting "the burden of compensation a little bit less from wages and a little bit more towards customers," Tedeschi argued.

In general, the policy would "incentivize workers to earn and report as much of their income in tip form as possible" and, depending on the size of the policy, "could also have effect on total wages," York added.

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Tedeschi speculated that, should these proposals become law, they would add pressure on both the employee and employer to ask customers to tip more, which may lead customers to cut back on how much they tip.

"You might see a rebellion against the traditional 18 to 20 percent tip in service industries, and if other industries try to get in on tipping, customers may not go along with that at all," he said. "They may not embrace it."

Stripping tips of federal taxes is also guaranteed to deepen the federal deficit, though exactly how much would depend on whatever provisions the proposed legislation includes. According to the Tax Foundation, exempting federal income tax from tips could cut revenues by at least $107 billion over 10 years.

If both federal income and payroll taxes on tips got the boot, revenue would drop by $150 billion to $250 billion over the same time span, while just axing federal income taxes on tips would lead to a loss of about half that value, the Committee for a Responsible Federal Budget estimated.

Still, Tedeschi said that Harris' apparent limiting of the proposal to service and hospitality workers is an important distinction in how it protects against the potential for fraud through occupations "reclassifying or shifting income and calling it tips" that a broader scope poses.

As for what Trump has seemed to propose thus far, the extent seems to end at tangibly benefitting the "narrow slice of tipped workers," Tedeschi said. Weighed against the GOP nominee's 10 percent tariff proposal, which Tedeschi said would raise the cost of living for a low-income family by $2,500 a year, the impact of such a policy is questionable.

"Tariffs are a tax that are shouldered more by middle and working class families than they are by upper class families," he said. "So you have to think holistically about his entire agenda in that sense."

York and Tedeschi said that, rather than floating proposals on eliminating tips on taxes, the candidates' attention to tax policy would be better focused on other areas or subjects.

In Harris' case, pushing for a significant bump in the currently "completely inadequate" federal minimum wage would make for a "far and away" more effective means of reaching low-wage workers, "especially when we're talking about the federal minimum wage that has not been updated, or indexed to inflation in more than a decade."

"The candidates have much bigger tax policy issues to address, like spelling out how they will navigate the expiration of the 2017 tax law," York added. "Policies like this distract from the bigger debate."