Hot Tip

A couple of months ago I was chilling-out at the airport in Chicago waiting for a connecting flight.  At a kiosk to purchase an $8 bottle of water the credit card terminal said ADD GRATUITY.  What the hell?  Tipping an attendant watching me process my own transaction?  An interaction that lasted less than 15 seconds?  I even had to fetch my own water.  The attendant's sole purpose was to scan the bar code.  Some days I think that this business of tipping has gotten out of hand.  

It's madness and it makes me grumpy.

Yet the madness has spread.  Both contenders for the White House have gone on record as supporting an exemption of tipped income from the federal income tax.  Donald Trump had this to say: It's a large group of people that are being hurt badly.  They make money - let them keep their money.

It's not an original idea and it enjoys a reasonably high level of populist support.  Because, (surprise, surprise) nobody likes to pay income taxes.  Nevertheless it is bad policy.  Allow me to explain.

Between 1972 and 1978 I worked in the restaurant business as a waiter and bartender.  As a consequence I know how tipped income works.  I made a pretty good living with this arrangement considering it was a part-time gig.  And just like today tips were taxable income fifty years ago.

In an election year this concept plays well with workers in the hospitality industry.  It is Silly Season after-all and Nevada also happens to be a swing state so I get the need for pandering.  Nevertheless, carving-out one form of income for preferential treatment while ignoring all other sources of income runs afoul of all manner of unintended consequences.

Most obvious is how are you going to pay for it?  The nonpartisan Committee for a Responsible Federal Budget (CRFB) estimated that the Harris plan would increase deficits by $100 to $200 billion over a decade.  The Trump plan to exempt all tips from federal income AND payroll (FICA) taxes would reduce revenue by $150 billion to $250 billion.  So, how do you replace the loss of revenue?  Eliminating waste fraud and abuse ain't gonna cover it.  That worn-out refrain is bogus.  Unless you're willing to raise someone else's taxes the deficit and debt will balloon at an even faster rate.

The Trump plan has an additional consequence.  Exempting Social Security and Medicare reduces revenues to these programs thereby accelerating the insolvency dates for both.  It also impairs an employee's eligibility and level of retirement benefits.  

What about the matter of fairness?  A hotel or resort's tipped waitstaff may make the same hourly wage as someone working in a warehouse.  Is it fair that the person who pours you a drink pays less income tax than the person who is filling your Amazon Prime order?

Tipped workers tend to skew lower income.  Consequently, almost forty percent of them do not earn enough to to pay any federal income tax anyway.  They do pay FICA payroll taxes for Social Security and Medicare however.

The CRFB has also raised a caution flag about the behavioral effects of making tips tax free.  The group suggests that this would incentivize employees and employers to make gratuities  a larger share of their income.  The practical consequence is the airport kiosk experience I shared at the outset.  When we swipe our cards we're going to see ADD GRATUITY not just at restaurants, cafes and bars - but a growing number of additional businesses.

Madness that will make me really, really grumpy.

Finally, some creative accountants, financial guys and other geniuses will get around to finding or creating loopholes for those at the higher rungs of the income ladder to exploit this federal largess.  Trust me on this.

If you really care about workers on the lower rungs of the wage ladder instead of singling-out a particular subset of workers for preferential treatment; how about a policy that treats everyone equitably.  All that really matters is disposable income; as it is lower-paid labor that struggles more than anyone else with the impacts of inflation. 

Consider this:  Expand the personal exemption, Earned Income Tax Credit, Child Tax Credit, and lower marginal tax rates.  Or some combination of all.  Using the existing income tax framework is an easier approach as we're already familiar with how it works.

And don't lose sight of paying for it.  Otherwise you're just blowing smoke up somebody's backside.