Trump And Harris Agree on No Tax On Tips

Photo by Canadian2006, CC BY-SA 4.0 , via Wikimedia Commons

Vice President Kamala Harris endorsed “no tax on tips” during a Las Vegas rally over the weekend, following weeks of former President Donald Trump bringing it up at his recent rallies and interviews.

Cue the disagreement over the singularity of the two presidential candidates actually agreeing on something:

NPR:

“This was a TRUMP idea – She has no ideas, she can only steal from me,” Trump posted on Truth Social. “Remember, Kamala has proposed the LARGEST TAX INCREASE IN HISTORY – It won’t happen.”

In response, a Harris campaign official told NPR that the vice president’s policy proposal is distinct from Trump’s — and she intends to deliver on it.

“As president, she would work with Congress to craft a proposal that comes with an income limit and with strict requirements to prevent hedge fund managers and lawyers from structuring their compensation in ways to try to take advantage of the policy,” the official, who isn’t authorized by the campaign to speak publicly, said. “Vice President Harris would push for the proposal alongside an increase in the minimum wage.”

Regardless of its origin and ownership, the no tax on tips idea is gaining bipartisan political steam. On Capitol Hill, Sen. Ted Cruz, R-Texas, introduced the No Tax on Tips Act in July with the support of Democratic Sens. Catherine Cortez Masto and Jacky Rosen, from Nevada, and the powerful Culinary Workers Union Local 226. A companion bill — introduced by Florida Rep. Bryon Donalds — is also making its way through the House.

Just for the record, no tax on tips isn’t a new idea nor original to either candidate, and the modern debate over taxing of tips goes back to at least the Reagan administrations tax overhauls in the early 80s.

But is this bipartisan adventure in populist rhetoric good policy? Something that is even rarer than the opposing presidential candidates agree is ideologically opposed policy wonks agreeing. And there is bipartisan agreement that while a great stump speech line, no tax on tips probably isn’t good policy. Albeit, coming to that conclusion from different directions.

From The American Prospect:

The combination of needing that endorsement and not wanting to have Trump outflank her on something that sounds vaguely populist led Harris to say these words on Saturday: “When I am president, we will continue our fight for working families of America, including to raise the minimum wage, and eliminate taxes on tips for service and hospitality workers.” A campaign official said these two concepts, which would need congressional approval, would travel together.

No taxes on tips is generally a poor idea where there are other good ones available. It would somewhat unfairly segregate people who make the same income by virtue of how that income is technically collected. It invites gaming of the system, where real estate and stock brokers, lawyers, or even hedge fund managers can recharacterize their income as tips and get a huge tax break. (The Harris aide said they would put income limits and “strict requirements” to prevent such gaming.)

No taxes on tips is generally a poor idea where there are other good ones available.

It would nullify efforts to improve reporting compliance on tips. And if this affected payroll as well as income taxes—which businesses would certainly push for on the employer side as well—it could catastrophically reduce what tipped workers pay into and get out of Social Security. Worker retirement income would be based only on their meager base wages, while Social Security and Medicare would lose something like $250 billion over a decade, hastening the insolvency of the trust funds.

A great number of workers don’t qualify to pay much, if any, federal income taxes, particularly in the service and hospitality sector. That means this tax break may not do much for current workers while potentially hurting them in retirement. If you do owe income taxes as a service worker, you’re on a higher end of the income scale, so the break is generally regressive.

From Tax Foundation and friend of OT Alex Muresianu:

By making one type of income (tips) exempt from income tax, while other types of income (most importantly, wages) remain taxable, the proposal would make more employees and businesses interested in moving from full wages to a tip-based payment approach. That would mean more service industries adopting the restaurant industry approach of a list price up front and an expected voluntary tip at the end of the transaction.

This kind of behavioral response makes it difficult to estimate the cost of the no-tax-on-tips proposal. A simple analysis of tipped income suggests a lower bound cost of around $107 billion over 10 years for an income tax exemption only, assuming tips as a share of total wage income remains as it was in 2018 and applying the marginal tax rate on wages faced by taxpayers making between $30,000 and $40,000 (waiters and waitresses earn a median wage of about $32,000 and a mean wage of $36,500).

Small behavioral effects, such as higher tips in existing tipped occupations, would incrementally raise that cost. More substantial behavioral responses, such as previously untipped occupations introducing tipping, could make the policy dramatically more expensive.

One could imagine a scenario in which, say, highly compensated lawyers or accountants begin to receive some of their income as voluntary tips. Lawmakers could design the exemption to prevent or minimize exploitation, such as restricting the tax exemption to taxpayers below a certain income threshold or only to tipped income received in traditionally tipped occupations. Additionally, for tip income to be tip income, the payment must be made voluntarily by the customer and cannot be previously agreed upon (among other restrictions), so arrangements to agree upon a “tip” before providing, say, legal services would be illegal, but that could prove challenging for the IRS to enforce. Additionally, lawmakers could reduce the incentive to recharacterize income by placing a cap on the amount of tip income that could be exempted.

The existing no-tax-on-tips bills do not offer much in terms of safeguards to prevent potential abuse. But even with safeguards, the policy would be poorly targeted at low- and middle-income earners, given the relatively small share of the population working in tipped occupations. Worse, the exemption itself, and any safeguards added, would add to the complexity of the tax code overall.

So, what say you?