After former President Donald Trump said he would like to eliminate taxes on tips for service workers, Vice President Kamala Harris followed suit, announcing she also supported eliminating taxes on income raised through tips. But is it a good idea?
Trump first raised the idea in a June speech in tourism-heavy Nevada.
“Hotel workers and people that get tips, you’re going to be very happy because when I get to office, we are going to not charge taxes on tips,” he said. “We’re going to do that right away, first thing in office,” he pledged. Trump proposed this idea after talking to a server in Las Vegas.
“But I said to her, let me just ask you a question. Would you be happy if you had no tax on tips? She said, what a great idea,” he said.
Harris followed suit. Speaking to a crowd at a campaign rally also in Las Vegas on Saturday, she promised the same as Trump.
“We will continue to fight for working families, including to raise the minimum wage and eliminate taxes on tips for service and hospitality workers,” Harris said.
The swing state is home to more than 350,000 workers employed as waiters, bartenders and cocktail servers. Across the U.S. there are at least 6 million tipped workers, according to IRS data from 2016.
Could this policy help this demographic or supply the government with a list of unintended consequences?
How would slashing tax on tips affect workers?
Howard Gleckman, a senior fellow at the Urban Institute, a think tank dedicated to economic and social policy research, said it is largely unclear whether the two politicians are suggesting repealing the payroll or income tax on tips.
“The consequences for workers get pretty complicated,” he said. If it’s affecting the payroll tax, a worker will have “a little more take-home pay ... but if you don’t pay Social Security payroll taxes or Medicare payroll taxes, you don’t get Social Security or Medicare when you retire.”
Should Trump or Harris slash the income tax on tips, it won’t affect a low-income tip workers’ after-tax income, since those making below $29,000 are already exempt from federal income tax. But there are other consequences.
In a scenario where someone’s income comes only in the form of tips, they may not file a tax return and can inadvertently lose the opportunity to claim various tax breaks. The child tax credit and the earned income tax credit, available to low- and moderate-income households, are worth $2,000 and $4,000 per child, respectively.
“Those credits are refundable, which means that if you receive more in credits than you owe in tax, the government writes you a check for the difference,” Gleckman said.
Effects on high-income workers
Higher-income tip workers — “there’s a small fraction of them who make between $50,000 to $60,000″ — would enjoy a bigger tax break with such a policy but they can also lose out on tax credits and entitlements.
Cutting tax on tips would also incentivize earning income on tips and not wages. Say you’re a warehouse worker, earning $35,000 a year, the same as a server at a restaurant, the warehouse worker would have to pay taxes on their earnings but the server wouldn’t.
“It isn’t fair. It doesn’t make a lot of sense but the other thing it’s going to do is it’s going to encourage more people to become tip workers,” Gleckman said, “and we don’t want that.”
All this depends on how the law is written, he added. The IRS currently defines tips as intermittent and unpredictable, barring freelancers or one-time sellers from categorizing their income as a tip, but this definition could be tweaked.
Would slashing tax on tips be fair?
It wouldn’t be the first time changes in the tax structure are modified. Most times, the alterations affect tax codes for the affluent, who are motivated “to recategorize their income into the lower taxed version.”
But “if the tax rate on one form of income is 37% and on another form of income is zero, as you can imagine, there’s a giant incentive for me to recategorize my income and make it look like it’s a tip and not ordinary income,” said Gleckman. “So, there will be a lot of lobbying pressure to write the legislation in a way that allows for these kinds of loopholes.”
The tax expert noted that large loopholes will allow more income to be categorized as tips, costing the U.S. Treasury money and adding to the ballooning U.S. national debt of more than $35 trillion. “That’s going to put some constraints on Congress’s willingness to make this kind of a completely free ride,” Gleckman added.
Sen. Ted Cruz, R-Texas, introduced the No Tax on Tips Act last month, as did Rep. Byron Donalds, R-Fla., in the House at the same time.
“This common-sense, pro-worker legislation allows millions of tipped workers — including bartenders, waiters, and beauty professionals — to keep more of their hard-earned paycheck,” Cruz said in July. The bill doesn’t single out any specific type of tip worker.
Gleckman said he has one question for lawmakers supporting this bill: “Why do you want to give tip workers tax free income but not the wage workers making the same amount in a different occupation? What’s the possible justification for that?”