Yes, exempt tips from tax – Institute of Competitive Entrepreneurship
4 mins read

Yes, exempt tips from tax – Institute of Competitive Entrepreneurship

Republican candidate Donald Trump’s proposal to make tips tax-free is a good idea, and not just because it would be a significant tax break for working Americans. It will also continue to be beyond the reach of the regulatory state, which has so far had limited control over the practice.

Tipping is a surprisingly complex and often controversial economic issue because it has historically been unregulated. Almost all laws, regulations and taxes related to the economy focus on employers. Customers pay employers, who then use that income to pay their employees. The government, at various levels, adds sales taxes and payroll taxes to these transactions and then taxes the company’s profits. Trade unions are based on collective labor agreements with employers.

Tipping can get around all of this. Historically, tip money went directly from customers to employees, bypassing management entirely. Regulators and trade unions were also largely out of the loop. Tips are taxed and regulated to some extent, but until recently the government had no way to properly estimate how much workers received. In reality, it was an honor system and it was widely suspected that workers underestimated the amount they received.

Labor unions and several union-allied labor groups have sometimes been critical of tipping. They claim management encouraged the practice in an effort to weaken unions because collective bargaining agreements set wages and compensation levels but cannot control tips.

The practice of tipping has received little attention from economists, with University of Washington professor Tony Gill being an exception. Because it wasn’t closely monitored by regulators, economists had little data to analyze. It is also a North American tradition that is not widely practiced elsewhere in the world.

However, in recent years, the US economy has begun to move away from cash and in its place is increasingly using credit cards and app-based payment systems. Customers no longer leave change left on the table after a $20 bill. Electronic transactions still allow tipping, but they can be easily tracked, which means regulators now have a much more accurate picture of how much is paid in tips. As a result, workers are increasingly oppressed.

The IRS reported that $20 billion in tips were reported in 2008, and in 2018 that amount almost doubled to $38 billion. Customers didn’t start giving more tips, they just started giving them via credit cards and phone calls, which the IRS can do to monitor much more easily. Therefore, the tax office collects a larger share of the salaries of waiters, bartenders, hairdressers and other service industry employees. Closer monitoring of tipper trucks means that regulators will also be much more willing to exercise control over them.

Trump’s proposal would put more money directly into the pockets of working Americans, without creating more costs for employers or raising prices for customers. Customers would also benefit because employees would work harder to make a good impression and earn tips. “We’re going to do this right away in office because this has been a contentious issue for years and you’re doing a great job of it,” Trump said at a rally in Reno, Nevada.

Liberals reacted maliciously to this proposal. Saru Jayaraman, president of the One Fair Wage advocacy group, called it “pro-worker” because it “does not actually address economic instability and poverty.” OK, so it won’t solve the problem, but it will put more money in the pockets of the workers Jayaraman claims he wants to help. You’d think she’d be more positive about the idea.

Liberals are probably concerned that a tip tax exemption will result in more employers encouraging customers to pay more in tips. This would allow employers to reduce workers’ overall pay because tips could make up the difference. This is already common in some sectors. Strip clubs often have arrangements in which dancers are paid almost exclusively in the form of tips from customers.

This is mainly a problem for regulators and unions who want a piece of the tipping action. So what? If employees are performing as well or better, they have no reason to care whether the money comes from the employer or directly from the customer.