No Taxes on Tips? There Are Better Ways to Help Low-Wage Workers

Raising the federal minimum wage and ending the subminimum wage for tipped workers are good places to start.

Sylvia Allegretto for the The Progressive

With the race for the White House heating up, a curious policy idea appeared seemingly out of nowhere: ending federal taxes on tips. While this policy shift may have wide appeal—most people aren’t going to say no to a tax cut—it would not translate into real benefits for workers struggling to make ends meet. In fact, it could do harm, and it may even deliver a new tax perk to the rich.

“No taxes on tips” makes us think it would benefit certain workers: the restaurant server pulling a double shift to pay the rent or a member of the cleaning staff at a major hotel chain. Surely these workers deserve better—and what could be better than giving them a chance to save on their tax bill?

It’s not so simple. For starters, tip workers make up a small fraction of the U.S. workforce—about 2.5%—and more than one-third of them do not even earn enough to pay income taxes in the first place. Cutting the federal tax does nothing for this group, except reduce the amount that they contribute to Social Security. Some of these workers could also lose out on other vital programs, like the Earned Income Tax Credit.

While there are still almost no details about how a tax-free tips policy would work, there is the very real possibility that wealthy earners would take advantage of any new system to shield their earnings from federal income taxes.

There are better options than a poorly designed “no tax” gimmick that leaves behind the majority of tipped and other low-wage workers. To win better pay for workers, we could start with raising the 15-year-old $7.25 federal minimum wage to at least $15 an hour. This would provide a more significant boost; about 1 in 8 workers earn less than $15, and most are in the states that have a $7.25 minimum wage.

What’s worse, tipped workers may be paid a subminimum cash wage by their employer that is as low as $2.13 per hour, an amount frozen in place in 1991 at the federal level. This is designed to benefit employers, not workers; the $5.12 difference between the federal minimum and subminimum wages is known as the “tip credit.” In effect, this is the portion of workers’ wages subsidized via customer tips.

These tip credits across the United States are at least $9 in nine states, and more than $11 in Delaware and Maryland. They represent enormous wage subsidies to employers for each and every hour a tipped worker works. It’s no wonder that consumers are showing signs of being “tip-tired”—it is past time to phase this policy out.

While there are still almost no details about how a tax-free tips policy would work, there is the very real possibility that wealthy earners would take advantage of any new system to shield their earnings from federal income taxes. Without adequate safeguards, some high earners would simply reclassify a portion of their income as tips. This would represent one more avenue for the wealthy to avoid paying their fair share.

Historically, the tipping economy has always been about denying workers a fair wage. It is a practice that dates back to the feudal systems of the Middle Ages and the post-Civil War period here in the United States, when white employers used it to deny formerly enslaved Black workers a fair wage for their labor. Today, tipped workers are often forced to deal with unexpected fluctuations in pay and scheduling and often lack access to employer-provided healthcare, paid sick leave, or holiday pay.

There are plenty of policies that would improve the lives of low-wage workers—raising the federal minimum wage, for starters, and ending the subminimum wage for tipped workers is a good place to start.

© 2023 The Progressive

Sylvia Allegretto is a senior economist at the Center for Economic and Policy Research.