Here’s a tip — don’t make gratuities tax-exempt

Question: What’s worse than a campaign promise of a bad tax policy?
Answer: A campaign promise of the same bad tax policy by both major presidential candidates.
Vice President Kamala Harris could have promised so many things to gain votes during a recent campaign trip to Las Vegas. Unfortunately, she chose to promise to exempt tips from federal taxes.
This is the very same thing former President Donald Trump promised during a similar trip to Las Vegas earlier this year. As a campaign strategy, that was clever — neutralize your opponent by promising what he promised.
But as public policy, it’s a bad idea. It was a bad idea when Trump said it, and it’s a bad idea when Harris says it.
It is, however, good politics. Las Vegas has far more service and hospitality workers than it has economists, so the “don’t tax tips” line is sure to get rousing applause every time.
Economists, however, will have the last word.
As news reports have made clear, both liberal and conservative economists agree on this one. Making tips tax-exempt would increase the national debt at a time when that is already a concern. That, in turn, might harm Social Security and Medicare (depending on how the exemption is structured) at a time when both programs face looming cash shortfalls.
Politico said experts are trying to calculate the total cost to the treasury. The Committee for a Responsible Federal Budget estimated it could be between $100 billion and $250 billion over a decade. But that depends on the details, which so far are few from either campaign. Also, it’s easy to underestimate the impact, given that such a policy change would likely affect behavior over time, making the economy more tip-based.
“It’s one bad idea layered on top of another,” Howard Gleckman, a Tax Policy Center senior fellow, told Politico. “There are not a lot of tax upsides.”
Experts say a lot of tips already go unreported. Making them exempt would be a huge incentive for employers and workers to make jobs even more tip-based. Some workers not currently associated with tips, such as auto mechanics, may turn to that model to avoid taxes.
If you don’t like the way servers, from hair stylists to fast-food workers, ask for tips using electronic devices these days, this idea would likely proliferate the practice.
NPR quoted Steve Rosenthal, senior fellow at the Urban-Brookings Tax Policy Center, as saying the policy would create problems with inequity. A server in South Carolina, whose salary is structured so that tips make up a large portion of his or her pay, would benefit more than one in California, where tips might be a lesser portion of salary.
“Why treat employees, who perform similar kinds of services, much different from a tax standpoint just because the first earn tips and the second don’t?” he said.
The biggest challenge with such a policy may be the difficulty it presents for government oversight and regulation. Many tips are paid with cash. Reporting is unreliable and not done in a uniform manner from business to business. Some businesses collect all tips and redistribute them equally to employees. Others let workers keep what they have been given.
“How are we going to tell who is receiving a tip, and when that tip crosses a line into wages?” Rosenthal told NPR. “How will we prevent investment bankers, say, from getting tips? And if we impose income limits, well, wouldn’t we expect low paid workers just to demand a tip rather than compensation?”
We’d like to say this is little more than a passing campaign fad, but already Sen. Ted Cruz, R-Texas, has a bill that would exempt tips from income taxes, while still making them subject to payroll taxes for Social Security and Medicare.
Also, the idea is popular among the public, generally. Newsweek just published a poll by Redfield & Wilton Strategies showing 67% of Americans in favor of making tips tax-exempt.
But tax policies should be enacted based on principles, equity and fairness, not just popularity. They should do as little harm as possible to the economy.
A general cut in income taxes might stimulate the economy by incentivizing production. Exempting tips would only distort the economy while creating inequities.
“We’re in a campaign season — silly season,” Rosenthal told NPR. “A race to the bottom would be a better way to describe tax policy here.”
A much better campaign tactic would be for each candidate to one-up the other over ways to reduce the yearly budget deficit and retire the debt. That one likely wouldn’t get a lot of applause. It would, however, make sure that when the economists have the last word, everybody wins.