In the months ahead of the election, both former President Donald Trump and Vice President Harris have proposed policies that attempt to win over the votes of lower-income Americans. One of the most widely discussed policies that both have suggested is removing the federal tax on tips. The policy that Kamala Harris has suggested would exempt workers from paying federal income tax on tips if their income is below $75,000 a year. While this may appeal to some voters in the service industry, it fails to be an effective policy in helping lower-income individuals overall.
One issue that arises is that the policy is widely inequitable for those who do not work in tipped professions. The Yale Budget Lab estimates that for workers making under $25 an hour, less than 4% receive income in tips. People working in other low-paying industries, such as retail or warehouse jobs, would be completely left out of this policy. Additionally, they report that 37% of tipped workers already pay no income tax on their tips, so it would not be an improvement for over a third of tipped workers. While this policy may greatly improve wages for this small proportion of workers, it does not solve the issues impacting the remaining majority of lower-income workers.
On the other hand, some argue that this policy would benefit tipped workers specifically because the tipped minimum wage is as low as $2.13 per hour in many states, as opposed to the national $7.25 minimum wage. This is a common misconception. The $2.13 combined with tips must equal the minimum wage, making total earnings similar to the federal minimum wage. The earnings potential is also higher than that of an untipped job.
While the policy is ineffective at reaching many of the workers it aims to help, economists estimate that this policy could still cost from $10 billion to $15 billion per year to implement. Additionally, many other indirect effects could arise from this policy, such as a larger proportion of income being reported as tips and a shift in the definitions of tips to avoid paying taxes. This would cause even more losses for fiscal authorities than estimated. Compared to other policies, the costs of tax-free tips greatly outweigh the limited benefits that it could provide.
For example, a policy that could reach more workers would be further expansion of the Earned Income Tax Credit (EITC). This is a tax credit that requires recipients to work during a phase-in period and maximizes the possible tax credit at a specified income, while phasing out at higher income levels. This makes this tax credit designed to assist lower-income individuals, while progressively providing less assistance as income increases. Potential ways to improve this credit could be by either raising the maximum tax credit received or having a longer phase-out period, which allows people with a slightly higher level of income to also receive the benefits. An improvement made in 2021 saw a boost in the tax credit received by childless workers, which was previously very small relative to workers with kids. Following this increase in the tax credit, the poverty rate among childless adults decreased from 12.3% in 2019 to 10% in 2021. This policy is much more effective at reaching lower-income workers than removing a tax on tips.
Another popular policy option that would reach a wider range of low-income workers is to raise the federal minimum wage. While it is clear that raising the minimum wage would lead to a rise in income, economists debate whether it would lead to lower employment due to increased labor costs for businesses. The Congressional Budget Office found that raising the federal minimum wage to $17 an hour by 2029 would lead to an increase in earnings and family income for the lowest-income workers, although they also found it could reduce employment. Promisingly, they determined that while some of the workforce would experience unemployment lasting up to a year, for many it would persist over a shorter period. Ultimately, the study found that overall poverty would fall with an increase in minimum wage and the negative effects on employment would likely be outweighed.
While the no-tax on tips policies held by both candidates may garner support in swing states, the policy will be costly and ineffective at reaching the needs of a majority of lower-income workers. Implementing other policies such as improvements in the EITC or raising the minimum wage would prove to be more impactful.
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