(Fortune) - Presidential contenders Kamala Harris and Donald Trump found a rare point of agreement when they both proposed getting rid of taxes on tips.
For restaurant workers, tour guides, masseuses, anyone at all who makes tips, the benefits of the policy are obvious. Fewer taxes, which naturally means more money in their pockets. But for everyone else, the rare bipartisan proposal comes with several pitfalls: Less money in the Treasury, an inequitable tax code, and even more incentives for people to game the system.
What’s more, Trump’s and Harris’ versions of the proposal have both been light on details, experts note.
“It's easy to promise something like this, but they're not doing what's an important part, and that’s sort of finishing the policy,” said Keith Hall, a labor economist at George Mason University’s Mercatus Center and former commissioner of the Bureau of Labor Statistics. “Tell us how you're going to pay for this.”
The proposals would cost between $100 billion and $250 billion over 10 years, estimates the Committee for a Responsible Federal Budget.
Even setting aside the cost, the proposal would represent a wholesale change of how tipped employees are paid and how the U.S. tax system operates, with workers who make the same amount of money paying different levels of taxes. Should the policy become law, millions of workers would be incentivized to forgo salaries or hourly wages to reduce their income tax and business owners would likely gladly oblige to lessen their own payroll taxes.
“Typically, if you subsidize something, you get more of it,” said Hall, who is a member of the advisory board for the Committee for a Responsible Federal Budget.
All of this raises one of the most contentious questions of civic life: fairness.
“Why single out restaurant workers?” Hall said. “You got people who don't earn tips making the same amount of money. They don't get the tax break?”
It’s not ‘an economic issue, it’s a fairness issue’
There are two principles that make an income tax system effective and fair, according to Hall. One, that people who make more money pay more in taxes, and two, that people who make the same amount of money pay the same in taxes. “It's not quite so much an economic issue, it’s a fairness issue,” Hall said. “It’s also an important part for people's willingness to pay their taxes.”
That said, tax breaks like the child tax credit and the earned income tax credit do allow parents to pay fewer taxes to the government, and rampant inequality in recent decades has renewed charges that the current tax code is unfair. A Pew poll from 2023 found that about 60% of Americans believe corporations and the wealthy don’t pay their fair share in taxes. The tax system is also rife with legal workarounds for the wealthy, best embodied by the fact that many of the richest people in the U.S. paid very little federal income tax—and at times even none at all. The highest earners do so through maneuvers like the carried interest loophole, which allows fund managers to classify part of their compensation as capital gains rather than income. Capital gains are taxed up to 15% depending on the asset, while income is taxed up to 37%.
And tips are no less susceptible to being gamed, according to a report from the progressive think tank the Center for American Progress. A proposal to eliminate taxes on tips from Sen. Ted Cruz (R-Texas) and Rep. Byron Donald (R-Fla.) could also be used for tax abuse by the wealthy, the CAP found. “The incentive to recharacterize wages or even profits as tips is stronger for high-income individuals since their income tax rate is higher,” according to the report.
Cruz’s spokesperson Darrin Miller shot down the idea that Wall Street execs and other white-collar professionals would take advantage of the bill. “As for the hedge fund ‘loophole,’ that's not how tax law works,” Miller wrote in a post on X. “Tips are voluntary and the IRS defines requirements for reporting. Reclassifying non-tip income as tips has a name: tax fraud.”
A spokesperson for Harris said she would close such loopholes. “As President, she would work with Congress to craft a proposal that comes with an income limit and with strict requirements to prevent hedge fund managers and lawyers from structuring their compensation in ways to try to take advantage of the policy,” they said. The Trump campaign did not respond to a request for comment.
Fortune spoke to several business owners whose employees make money from tips, all of whom supported the policy proposal, but worried it could incentivize a similar gaming of the system. Unscrupulous business owners and their employees could try to rework their compensation structures to pay workers more tips than in wages, which would still be taxed, said Carl Sobocinski, who owns five restaurants in Greenville, S.C.
“We would have to be careful to make sure that people don't try to skate around the rule to pay less taxes,” Sobocinski said.
If that were to happen, the federal government would miss out on both the income tax from the worker and the payroll tax the business would have to pay. That would mean an even bigger hit to the already hundred billion hole in federal tax revenues, according to Bernard Yaros, lead U.S. economist at Oxford Economics. “How much would be lost in terms of federal revenue, just really depends on business behavior,” he said.
Tips, especially cash tips, have always been subject to a tacit ‘don’t ask, don’t tell’ mentality. For decades tips were largely cash payments that for the most part went unreported to the IRS. “Tips are notorious for not being reported income,” Hall said.
Lunch was $16.50? Here’s a twenty, keep the change. Movers lugged your furniture up three flights of stairs in July? Here’s a little something extra for you and the guys. But in an increasingly cashless society all those little acts of kindness become recorded in a credit card transaction log, forcing tipped workers to report them. In that sense, eliminating taxes on tips is a return to what was once an accepted, if not entirely government-sanctioned, status quo.
As a labor economist, Hall sees ripple effects across the economy from such a drastic change affecting millions of workers. Real wages for tipped workers would go up, but likely without an increase in the cost of everyday goods, which tends to happen whenever pay rises, Hall said. That sounds like a good thing in theory, he says, but that doesn’t mean no one is paying.
“The government would be picking up more of the tab,” he said. “There might actually be less pressure on the price of things like food, but of course, taxpayers are paying for that.”
By Paolo Confino
