When Donald Trump and Kamala Harris agree on something, it’s wise to exercise caution. Trump at one point mentioned not taxing income generated from tips, and some Republicans in Congress introduced legislation to that end. Now Harris has said she also supports not taxing tip income.
It makes more sense to understand these statements as bipartisan pandering in an election year rather than a serious effort at tax reform. Even as pandering, it is not very effective.
Trump’s position was viewed by some as a brilliant political maneuver to court low-income voters, especially in the crucial swing state of Nevada, which has a large hospitality industry. Now that Harris has copied him on that, any advantage he may have been able to press has disappeared.
Nevada state law already prohibits “tip crediting,” the practice by which workers can be paid below the minimum wage if they also receive tips. All Nevada workers are already required to be paid at least the Nevada minimum wage, which is $12 per hour as of July 1.
All along, the purported political calculus relied on a stereotype of low-income workers in the United States that does not conform to reality. Only about 2.5 percent of U.S. workers are in tipped occupations, and the proportion is not much greater for low-income workers. Only 5 percent of workers who make less than $17.66 per hour are in tipped occupations. Less than 4 percent of workers who make less than $25 per hour are in tipped occupations.
It is true that the tipped workers who do exist tend to have low incomes, but that means many of them already pay no federal income tax. Exempting tips from taxation would not help them reduce their income-tax bill, which is already zero. With refundable tax credits that already exist, many low-income workers in the U.S. end up making money from filing their income taxes.
Since exempting tips from income tax wouldn’t really do much for workers, it would also not really do much to federal revenue, so it might be tempting to think there’s no harm in passing it anyway. The problem is that if the government makes it official that tips are not taxed, that creates incentives to shift more compensation into tips, opening up a potentially wide avenue for income-tax avoidance by people in any occupation and at any income level.
Smart tax reform seeks to broaden the tax base, to reduce distortions in the economy and treat different categories of money neutrally, and to reduce the tax rate, to lower the tax burden and shrink government hindrance to growth. Exempting tip income from taxation shrinks the tax base and doesn’t do anything for tax rates.
The Tax Cuts and Jobs Act was a good, though imperfect, recent example of smart tax reform. Its individual provisions will expire at the end of 2025. Whichever candidate wins in November will have to deal with that challenge almost immediately upon taking office. Rather than batting around bad tax ideas that aren’t even effective political moves, the candidates should focus on building on the TCJA and cutting government spending.