Why Are Taxes on Tips Causing a Stir?

Are you aware of the fact that both presidential candidates of the US have promised to exempt workers from paying taxes on their tips? Well, to look at the bigger prospect, some experts believe, these are just a bid to generate votes rather than actually solving the issues of tipped workers who are not financially stable.  

How the No-Tax-On-Tips Promise Came to Election? 

On 9th June 2024, former President and current Presidential candidate Donald Trump promised service workers in Las Vegas that he will end taxes on tips for workers. At the same place last weekend, Vice President Kamala Harris delivered a similar statement that highlighted "No-Tax-On-Tips." It can't be a coincidence that both candidates announced it in Las Vegas where leisure and hospitality are the dominant industry.  

EPI Action, a nonpartisan research and advocacy group, has criticized the "No Tax on Tips" policy. They argue that while the policy is intended to benefit tipped workers, it may instead favor employers and the wealthy, leaving many workers worse off. Their analysis suggests that the real benefits of this policy change could be skewed toward those already economically privileged. 

How Taxes Impact Tipped Workers? 

Tips are considered taxable income, but not all income gets taxed. It depends on how much someone earns in total. On average, tipped workers make $538 per week, including tips, while non-tipped workers make around $1,000 per week, according to 2023 data. Many tipped workers earn so little that they don't have to pay federal income taxes; Yale Budget Lab estimates that this applies to about 37% of tipped workers as you can see in below chart. 

So, only a small percentage of tipped workers would benefit from the tax break proposed by Trump and Harris—and that's without knowing the specific income limits either plan would set. 

Neither Trump nor Harris has clarified if their proposals would only apply to federal income taxes. But if we look at the No Tax on Tips Act proposed by Sen. Ted Cruz (R-Texas), it seems likely the exemption would only apply to federal income taxes. 

How Much Would It Save a Tipped Worker? 

It's tough to define tip earnings because they can vary a lot depending on the type of service workers provide and local minimum wage laws. However, here’s an example to illustrate this: imagine a server makes $19,000 a year in wages and an additional $15,000 in tips. Their total income would be $34,000. After taking a standard deduction of $14,600, they’d be left with $19,400 of taxable income, resulting in $2,096 in federal income taxes. 

If a no-tax-on-tips policy were in place, their total income would only be $19,000 since the $15,000 from tips wouldn’t be taxed. After the same $14,600 deduction, they’d have $4,400 in taxable income, leading to $440 in taxes. This means they'd pay $1,656 less in taxes compared to the first scenario. 

Therefore, a cashier earning the same $34,000 without tips would have the same $2,096 tax bill in either situation. So, under a no-tax-on-tips policy, the cashier would end up paying much more in taxes than the server. 

Could It Be Considered a Loophole? 

A tax exemption on tips could be exploited. For instance, people in high-income jobs, like lawyers, might change how they report their earnings to avoid paying taxes on part of their income. 

The Harris campaign told The Washington Post that her plan would limit the tax exemption to workers who earn below a certain income level in specific industries. This approach would stop high earners in jobs that don't traditionally involve tips from taking advantage of the exemption. As of now, there isn’t a bill from Democrats in Congress that aligns with Harris’s proposal. 

On the other hand, Trump’s plan and the No Tax on Tips Act from congressional Republicans don’t restrict which industries are eligible or set any income limits. 

Could It Increase the Federal Deficit? 

Cutting taxes reduces government revenue, which can worsen the federal deficit over time. Currently, the deficit stands at about $1.52 trillion, according to the U.S. Treasury. The Committee for a Responsible Federal Budget estimates that making tips exempt from federal income tax would cost between $100 and $200 billion over ten years. If tips are also exempt from payroll taxes, that figure could rise to $250 billion. Experts warn that excluding tips from payroll taxes would have broader effects on Social Security and Medicaid programs. 

“These programs are already facing financial problems and could need intervention within the next ten years,” says Pomerleau. “If $38 billion is removed from Social Security and Medicare, it would speed up these issues.” 

Raising The Minimum Wage Would Have a Bigger Impact 

At a campaign rally in Las Vegas last weekend, Harris promised to eliminate the tax on tips and raise the minimum wage. However, she didn’t mention getting rid of the subminimum wage, which could make an even bigger difference for tipped workers. 

“If the goal is to help tipped workers in the U.S., why not focus on raising the minimum wage?” Cooper asks. 

Raising the minimum wage is just one way to support low-wage workers. Other strategies include expanding programs like the child tax credit, earned income tax credit, and Medicaid. Interesting take, isn't it? Let's see what happens next. Stay tuned and keep following us for more updates.