Consider This from NPR - How would banning taxes on tips actually work?

Episode Date: August 25, 2024

Both major party presidential nominees Donald Trump and Kamala Harris are on the same side of one issue. Getting rid of taxes on tips. But what would that really look like in practice? Wailin Wong and Darian Woods from NPR's daily economics podcast, The Indicator, dive into the potential guardrails for a policy that many economists believe could easily go off track. For sponsor-free episodes of Consider This, sign up for Consider This+ via Apple Podcasts or at plus.npr.org.Email us at [e-mail] more about sponsor message choices: podcastchoices.com/adchoicesNPR Privacy Policy

If you've ever had a job where you worked for tips, here's an economic proposal you might find appealing. It's called no tax on tips. No tax on tips. No tax on tips. Earlier this year, Donald Trump began pitching this idea of ending federal income tax on tipped wages. And then, this month, We will continue our fight for working families of America. Kamala Harris echoed the idea of no tax on tips during a speech in Nevada. And eliminate taxes on tips for service and hospitality workers. So you can hear some enthusiasm for this policy idea, right?

But you know who actually hates this idea? Economists and tax experts like Howard Gleckman. It's a terrible idea. Gleckman's a senior fellow at the Urban Brookings Tax Policy Center. He and other economists say this is actually a bad idea for many reasons. For one, there's unfairness. For instance, why should a waiter get part of their income tax-free, but the dishwasher in the back doesn't? Nor would someone who works a cash register at a grocery store. And then there's a concern that some people could game the system. Like, what would stop a high-paid corporate lawyer from claiming their six-figure salary as tips?

So consider this. Leaders in both parties are pushing this idea of tax-free tips. So consider this. Leaders in both parties are pushing this idea of tax-free tips. How do their proposals differ? And is there any way to avoid the downsides economists are warning about? From NPR, I'm Adrian Ma. It's Consider This from NPR. Donald Trump and Kamala Harris are on the same side of one issue, which is getting rid of taxes on tips. But what would that really look like in practice? And how could these policies be written in a way that is fair and doesn't just, you know, create opportunities for people to avoid taxes? My colleagues over at NPR's daily economics podcast, The Indicator, have been

looking into potential guardrails for a policy that many economists believe could easily go off the track. Darian Woods and Waylon Wong take it from here. Shannon Lee is an esthetician, you know, skincare, beauty treatments. And she says she got into it because of her own acne. And she says when her customers come in with it, it is quite satisfying to treat. I think acne is like my favorite thing ever. You love acne? I love acne is like my favorite thing ever. You love acne. I love acne.

I bet Shannon and I both enjoy watching pimple popping content on social media. Sorry, Darian. No comment. Look, I'm not going to yuck your yum, as they say. It's very compelling. It's incredibly disgusting. I can't look at it. Now, Shannon has her own business in New York, and we spoke there with a treatment table between us.

Shannon says the mid-range for estheticians in New York is about $22 an hour, plus commissions and tips. Her employees earn about a third of their income through tips. We're talking $30 an hour or even more. Shannon gets tips too. So this proposal to make those tips tax-free sounds almost too good to be true. If you're to not have to pay taxes on those tips, would that be a good thing for you? Am I allowed to say yes? You're allowed to. Absolutely, this would help out.

Shannon thinks other workers and business owners might be tempted to change their fee schedules so that more income comes in as tips. I think it will change the people's perspective on how they structure everything. That is one of the big concerns from the tax experts, like Howard Gleckman from the Urban Brookings Tax Policy Center. When you tax income in different ways, people are going to work very hard to characterize their income in the lower tax form. Howard points to plenty of historical examples where a regulation or lower taxes for some types of income have meant that people changed how they get compensated. We all now take employer-sponsored health insurance for granted. Everybody, you have a job, you expect to get health insurance through your job. That didn't exist before World War II. Yeah, the Stabilization Act of 1942 froze wages and benefits. It was part of a wartime effort to control inflation. But it had a big

exception. Pension plans and insurance could grow. So they did. It led to these big, all-encompassing health insurance plans being a very normal part of American compensation in a job. This very American health care system is a historical accident fueled in part by people seeing loopholes and using them. Another example that really highlights what happens when you tax two different forms of compensation differently is something big shot financial people know really well. Hedge fund managers, private equity partners, they have learned that getting paid a salary doesn't work out the best for them tax-wise. If you're somebody, particularly somebody who's making a lot of money, and you can turn your income into capital gains, you're going to be

paying a maximum rate of 20%. If it's ordinary income or wage income, you're going to be paying a 37%. So there's a big incentive to change the way your income is categorized. Some call this the carried interest loophole. It's when in lieu of some salary, these finance people get a share of the profits from the deals the company's worked on. That's then taxed at that lower capital gains rate as it's considered a profit on selling an asset. The end result of all these loopholes and carve-outs means that the tax code can be gamed. Laws intended to benefit one group might actually benefit another. And the government finds it harder to raise revenue. So he posed the challenge to Howard. If the elimination of taxes

on tips had to be made, how could the unintended consequences be minimized? What kind of guardrails could be put in place to reduce gaming of the system? Like that hypothetical corporate lawyer with a tip jar. So this starts getting really complicated. I mean, you certainly could put in income limits. Capping the income at which you can get tax-free tips is something that Kamala Harris said she would do. So that would stop those wealthy white-collar workers from claiming their income as tips. Donald Trump's proposal doesn't have that detail. You certainly could try to define those occupations that are eligible for the tax-exempt tips and those that aren't. Again, this is something that Harris has included in her proposal,

to only allow this for hospitality and service workers. Trump, again, hasn't specified this. That said, Howard is skeptical that this would solve the problem. He says that people like freelancers can redefine what industry they're in. They will gain the system. They'll change the nature of their work just enough so it fits a definition and allows them to get the income. Howard says this behavior could even boil over into outright fraud. And the root of this, he says, comes down to a broader problem with the IRS. You can put down anything. The IRS doesn't have the resources to ID you to determine what your occupation really is. So it sounds like boosting IRS resources might be part of your big policy proposal.

Oh, I'm a fan. I think it's a great idea. Ultimately, though, Howard was just kind of playing along with us. The bottom line really is, you know, it's unworkable. You can't. I mean, I'm not going to sit here and try to fix something that shouldn't happen and shouldn't actually be fixed. Well, I appreciate you being game at least enough to think about the hypothetical. Yeah, I try, but I'm not going to help them out on this. They're making this mess. They've got to get out of it themselves. What Howard thinks would really support tipped workers would be an increase in the federal tipped minimum wage, which is currently

at $2.13 an hour. Yeah, that surprises a lot of people. I mean, this varies state by state, of course, but for some states, that is the minimum wage for tipped workers. Yeah, I mean, $2.13, that's like barely going to buy you a fountain drink at the restaurant you're working at, you know? Yeah, and so Howard hopes that maybe bringing up that tipped minimum wage could push back against this entire system of compensating people through the whims of their customers. When you go to Europe and there's less pressure to tip, how do you feel? I feel great. I actually, I'm one of those people who really does resist

the whole tipping culture. Yeah, I bet Howard hates those pop-up screens that are everywhere asking for tips left and right. Yes. And Kamala Harris's proposal is paired with an increase in the minimum wage, but it's unclear yet whether that's an increase in the tipped minimum wage. Trump hasn't advocated for an increase in the minimum wage. And so just stepping back, do we think that removing taxes on tips is actually likely to happen? You know, it's a bipartisan issue. Politicians on both sides of the aisle support it. You've got Republican Senator Ted Cruz who introduced a bill,

the No Tax on Tips Act, earlier this summer. Democratic Representative Stephen Horsford said last week he's going to introduce another bill. This one's going to be called the Tipped Income Protection and Support Act. So there's a real possibility it might happen. This might also have something to do with Nevada being a battleground state. It's a big state for tipped workers. You've got one in five workers there working in leisure and hospitality. Oh, wow.

Yeah. So no doubt. It may not please the Howard Glickmans of this world, but it's good politics. That was Waylon Wong and Darian Woods from the Indicator from Planet Money podcast. This episode was produced by Angel Carreras. It was edited by Kay Kincannon and Adam Rainey. Our executive producer is Sammy Yenigan.

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It's Consider This from NPR. I'm Adrian Ma.