Economists explain hidden downfalls of ending taxes on tips

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• Amna Nawaz:

  Tax cuts and credits have been a popular theme during this campaign.

  Former President Trump's latest proposal is ending a cap on the federal deduction taxpayers get for paying state and local taxes, a cap he implemented as president and a change that could cost more than a trillion dollars over a decade. Both candidates have also proposed several tax breaks and have not always explained how to pay for them.

  That's true of one idea Trump and Vice President Harris support, no taxes on tips.

  Economics correspondent Paul Solman looked at what's behind that proposal and some concerns around it.

• Paul Solman:

  Prince Chiketah (ph), bartender at Busboys and Poets in Washington, D.C., 80 percent to 90 percent of his income from tips. Suppose they were no longer taxed?

• Prince Chiketah, Bartender:

  That would be great.

• Paul Solman:

  No taxes on tips. It was a proposal first floated by former President Trump in June.

  Donald Trump, Former President of the United States (R) and Current U.S. Presidential Candidate: When I get to office, we are going to not charge taxes on tips.

• Paul Solman:

  Vice President Harris adopted the idea in August.

  Kamala Harris, Vice President of the United States (D) and U.S. Presidential Candidate: 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.

  (Cheering)

  (Applause)

• Paul Solman:

  On Capitol Hill, don't-tax-tips bills were introduced this summer, with bipartisan support. What's the average tip you get?

• Prince Chiketah:

  Anywhere between $15 and $20.

• Paul Solman:

  For most Americans, a standard tip at a sit-down restaurant is 15 percent or less.

  Who are the big tippers?

• Man:

  Families, parents who have kids, they tip really well.

• Jordan Cole-Sanni, Server:

  Most people tip me 20 percent, which is awesome.

• Paul Solman:

  Server Jordan Cole-Sanni says tips account for 80 percent or more of her income. What would your reaction be if tips were no longer taxed?

• Jordan Cole-Sanni:

  I think every penny counts. So I think making more and not being taxed and being able to keep all the money that you work really, really hard for is always a positive.

• Paul Solman:

  And what do the tippers themselves think?

• Man:

  Them being able to keep that amount and not having to pay later is something that I do stand with.

• Paul Solman:

  Will that change your behavior?

• Man:

  It won't. I'm happy to hear that they will take more of it.

• Paul Solman:

  So, a policy with bipartisan support that benefits the low-wage worker. What's not to like? As I discovered, plenty.

• Ernie Tedeschi, The Budget Lab, Yale University:

  The issue is that there aren't a lot of tipped workers in America.

• Paul Solman:

  According to economist Ernie Tedeschi, tipped work accounts for just 2.5 percent of all employment.

• Ernie Tedeschi:

  Even among low-wage workers, it's only 5 percent of the lowest-wage workers that are tipped workers.

• Paul Solman:

  And more than a third of the lowest-wage workers don't have to pay any federal income tax, says policy analyst Erica York.

• Erica York, Tax Foundation:

  These are workers who already have a very low income tax burden, if they owe taxes at all. They may not make enough to owe taxes. If they do, they face the lowest marginal tax rates.

  They qualify for tax credits that can offset some or all of that tax liability. So, providing an exemption like this may not even be the best form of relief.

• Paul Solman:

  But whereas the very lowest-wage workers wouldn't benefit much or at all, says Ernie Tedeschi, employers would.

• Ernie Tedeschi:

  It shifts the burden of compensation away from the wage side, which the employers have to pay, to the tip side, which the customer pays.

• Paul Solman:

  So if tips were tax-free:

• Ernie Tedeschi:

  They're going to be a lot more workers that want tipped jobs. And so that's going to give employers the comfort and the ability to pay those workers a little bit less in wages than they otherwise would.

• Paul Solman:

  As it is, post-pandemic, there's been a proliferation of electronic prompts for tips.

• Ernie Tedeschi:

  Every single coffee shop I go to, every single fast-food place I go to asks for tips.

• Man:

  We're being asked now to tip for stuff that we never used to tip on before.

• Man:

  It's like a guilt factor where it's kind of like it's you just go ahead and like, I might do that at the moment.

• Paul Solman:

  So you are susceptible to the guilt?

• Man:

  Yes, I — definitely, the guilt does get the best of me, exactly, yes.

• Paul Solman:

  You too?

• Man:

  Yes, I would say it's 100 percent guilt-driven.

  (Laughter)

• Paul Solman:

  Phil Di Ruggiero (ph), for one, may be among those developing tip fatigue.

• Phil Di Ruggiero, Washington, D.C.:

  A little bit tired of getting that at every point of sale.

• Paul Solman:

  And since the proposal incentivizes tipping:

• Ernie Tedeschi:

  I think that's going to become more pervasive if this becomes law.

• Paul Solman:

  Which could lead to unintended changes in consumer behavior.

• Ernie Tedeschi:

  I think that there is a default assumption that consumers are just going to pay tips at the same rate that they have always been paying. I don't know that that's going to be the case. I think at some point consumers might get exhausted.

  You're essentially asking customers to pay higher prices, when they have already gone through a period of four years where they have rebelled against higher prices.

• Paul Solman:

  And as Steve Buscemi's Mr. Pink made clear in "Reservoir Dogs," tips are discretionary.

• Steve Buscemi, Actor:

  I don't tip.

• Actor:

  You don't tip?

• Steve Buscemi:

  No. I don't believe in it.

• Actor:

  You don't believe in tipping?

• Steve Buscemi:

  If they really put forth the effort, I'll give them something extra. But just tipping automatically, it's for the birds.

• Paul Solman:

  And how about this unintended consequence?

• Erica York:

  You could see a lot of income recharacterized to take advantage of the tax-free treatment. It's hard to predict how Many industries, how Many occupations could find a way to involve tipping in the transaction.

• Ernie Tedeschi:

  Let's say I'm a salesperson that gets a commission, or let's say that I'm somebody on Wall Street that gets a year-end bonus. So I reclassify my commission as a tip, or I reclassify my year-end bonus as a tip. The employer helps out because they will get a benefit. And so everybody wins.

• Paul Solman:

  Except the taxpayer.

• Ernie Tedeschi:

  Except — well, right, exactly, except for the taxpayer and the federal government. That's the sort of creative tax accounting that's on the line here if we don't have good guardrails.

  And I am not a lawyer. I am not an accountant. Now imagine what an actual smart accountant and an actual smart lawyer who's paid to do this 24/7 would come up with.

• Paul Solman:

  Now, the Harris campaign says she would push for an income limit and strict requirements to prevent such behavior. But here's yet another problem. Even when it comes to the low-income workers the plan is supposed to help.

• Erica York:

  There's not really an economic rationale to say a waitress who's making $30,000 a year deserves a tax cut, while a cashier at a convenience store who's also making $30,000 a year doesn't deserve a tax cut.

• Paul Solman:

  New York restaurateur Amanda Cohen eliminated tips years ago. Instead, she charges a bit so she can pay all her employees a higher wage. More fair, she thinks.

  Amanda Cohen, Chef and Owner, Dirt Candy: The prettier younger you are, the younger you are, the likely you are to make higher tips. And the older you are and the darker your skin, you're less likely to make as much.

• Paul Solman:

  But Cohen may have to drop her no-tip policy if tips are going to be untaxed.

• Amanda Cohen:

  How could I look at my servers and say, you would make a lot more money working at a tip restaurant because half of your wages won't be taxed anymore? I just don't think I could find anybody to work for me.

• Paul Solman:

  So, with all these caveats, why has the proposal been so readily embraced?

• Erica York:

  No tax on tips, it sounds like a good way to provide a tax cut to workers who work hard, who earn income, who need a break. I think that's why it's catching on politically.

• Ernie Tedeschi:

  This proposal is extremely popular in Nevada, which is heavily dominated by leisure and hospitality and gaming industry, as you might imagine, where tips are extremely important.

• Paul Solman:

  And Nevada is a swing state.

• Ernie Tedeschi:

  And Nevada is a swing state. Exactly.

• Paul Solman:

  In other words…

• Kamala Harris:

  Hey, Nevada!

• Paul Solman:

  … political business as usual…

• Donald Trump:

  People that get tips, you're going to be very happy.

• Paul Solman:

  … in sound bite America.

  For the "PBS News Hour," Paul Solman.