Both Kamala Harris and Donald Trump have proposed scrapping taxes on tips during their respective campaigns, but this proposal is nothing more than a red herring: a distraction from the really important tax stuff. Rather than truly help anyone, the proposal to ban taxes on tips would be targeted towards a tiny minority of the workforce and possibly completely distort the way American workers are paid.
Only 2.5% of the workforce work in tipped occupations, and only 5% of the bottom 25% of earners do. This proposal would only act as a tax cut for those individuals, and only if they actually had any tax liability which, with the standard deduction, EITC and possibly the Child Tax Credit, they may not. Increasing the standard deduction would be a far more efficient (and equitable) way to truly cut taxes for lower-income earners regardless of how they were paid. For example, a restaurant server and a store cashier may earn the same income of $30,000 a year, but under this proposal, the store cashier’s tax bill would be higher since they were paid exclusively in wages (making the whole amount subject to tax) whereas the server’s income may have been split 60/40 between tips and wages, thus lowering their tax bill and leading two individuals with the same income to have grossly inequitable outcomes. This is a constructed inequality which could simply be avoided by maintaining the status quo.
Under a tax code which taxed income and did not tax tips, employers might contemplate shifting their compensation models to a more tip-heavy structure like restaurants currently have. Pricing models could also shift to be listed lower with an expected (though not mandatory) tip accompanying the final bill. A widespread shift of this kind could cost millions in lost tax revenue as well as mount frustration amongst consumers. Current bills proposing the end of taxes on tips do not specify any limit to the tip amount (in either real dollars or a percentage of the transaction), which opens a huge loophole for tax avoidance.
While tipping is a huge part of American culture, this proposal – from both parties – is nothing more than an attempt to win some votes. The vast majority of Americans – both those who pay and those who are paid in tips – will see no tax cut as a result. The real tax issues this election are far more impactful – what is going to happen to the TCJA? What will the Child Tax Credit be? Will there be additional tariffs on foreign imports? Let’s not get distracted by the fine print at the bottom of the menu.
See also: https://taxfoundation.org/blog/tipping-trump-tax-on-tips/