NerdWallet's Smart Money Podcast - Why Experts Criticize “No Tax on Tips” and What It Means for Your Wallet

Episode Date: August 21, 2024

Learn why experts criticize the “no tax on tips” policy and what it could mean for non-tipped workers if tips become tax-free. Why are some experts criticizing the proposed “no tax on tips” policy? Could it really benefit tipped workers as intended? Hosts Sean Pyles and Anna Helhoski discuss the nuances of the “no tax on tips” proposals from presidential candidates Donald Trump and Kamala Harris and break down why tax experts are skeptical about its effectiveness. Then, they cover the latest financial headlines, including updates on retail sales, car prices, and the potential Kroger-Albertsons merger. Calculating how much car you can afford before you visit the dealership can save you hundreds, maybe thousands, of dollars in the long run. To do that for free, you can use NerdWallet’s car affordability calculator here: https://www.nerdwallet.com/article/loans/auto-loans/much-spend-car  In their conversation, the Nerds discuss: no tax on tips, tipping policies, federal income tax, tax exemption, tipped workers, minimum wage, inflation, car sales, grocery prices, Kroger Albertsons merger, consumer price index, CPI, retail sales, used car prices, payroll tax, earned income tax credit, child tax credit, recession, economic policy, subminimum wage, US presidential election, tax policy, financial headlines, tax credits, grocery merger, consumer spending, interest rates, federal minimum wage, Social Security, Medicare, restaurant industry, hospitality industry, tax loopholes, wage inequality, financial news, economic trends, car affordability, and tipping. To send the Nerds your money questions, call or text the Nerd hotline at 901-730-6373 or email [e-mail]. Like what you hear? Please leave us a review and tell a friend.

Welcome to NerdWallet's Smart Money Podcast. I'm Sean Piles. And I'm Anna Helhosky. And this is our weekly money news roundup, where we break down the latest in the world of finance to help you be smarter with your money. We'll go deep into a single topic and then leave you with the latest money headlines. Today, we're talking about a policy that, surprisingly, both presidential candidates support and has a catchy slogan, no taxes on tips. That's right. This summer, former President Donald Trump and Vice President Kamala Harris both proposed policies that would exempt tips from federal income taxes. As a former server myself, it sounds kind of awesome at first glance glance who doesn't like a tax exemption.

But tax experts across the board say it's a bad tax policy that also doesn't substantively help tip workers. Yeah, we'll dig into why experts don't like either candidate's no tax on tips policy. But there is a lot of context that listeners should hear first. We do exist in the context, Sean. Yes, we do, Anna. Listeners, we don't have to tell you all the times you need to tip because you do it all the time. Hairstylist, barista, server, delivery driver, valet. But Anna will list some anyway. Yes, tipped work is highly visible, so this fact may be surprising. There actually aren't that many

tipped workers in the U.S., just about 4 million people. In other words, 2.5% of the entire workforce are tipped workers. All you have to do to be considered one is earn more than $20 per month in tips. Legally, you must earn a cash wage in addition to tips, but here's the thing. The federally mandated minimum wage for tipped workers is actually a sub-minimum wage, a paltry $2.13 per hour. Tipped workers must have a sub-minimum wage plus tips that at least equal the federal minimum wage of $7.25 per hour, otherwise an employer has to make up the difference. The sub-minimum wage,

like that federal minimum wage of $7.25, hasn't budged since 2009. And we all know how prices have changed since 2009. That said, six states have banned the sub-minimum wage and most states have a minimum wage set above $7.25 per hour. And yet 36 states still have minimum wages for tip workers set below the federal minimum wage. Yale University Budget Lab found that the median wage among tipped workers is around $540 per week, including tips, while non-tipped workers earn a median of $1,000 per week. But let's be clear that tipped income varies widely from job to job and even from day to day. The work yields pretty unpredictable earnings, and a lot of those tips go unreported, although less than they used

to because more people tip on cards rather than cash. Yeah, I remember the last time I was a server way back in 2010. And some days I'd work a busy six hour shift and have $200 in my pocket, while other times it would be completely dead and I'd leave with $40 at the end of the night. That's rough. I was a server briefly in high school and it did not work out. Not because the tips weren't enough, mostly because I was a lazy employee who just watched Wheel of Fortune on the restaurant TV

instead of doing my job. But I guess that's neither here nor there. Oh yeah, that'll do it. Okay, so now that we have a sense of what tipped workers earn, here's how a no tax on tips proposal made its center stage in the presidential election. On June 9th in Las Vegas, former President Donald Trump announced his policy.

Then on August 10th, also in Las Vegas, Kamala Harris announced her own pledge, along with a promise to raise the minimum wage. President Biden has endorsed it, as have the Culinary Union 226 in Nevada and big business groups like the National Restaurant Association and the Professional Beauty Association. Republican Senator Ted Cruz also introduced a no tax on tips act. So far, there's no similar bill from Democrats. Now, neither Trump nor Harris has a completely fleshed out proposal, but there are distinct details between Kamala Harris's proposal and Donald Trump's. First off, Harris would make the exemption only available to the service and hospitality industry.

Yeah, some of the critique against Trump's proposal and Cruz's bill has to do with a potential loophole. Wealthier workers, like lawyers or hedge fund managers, could theoretically convert earnings into tips to avoid paying taxes on a portion of their income. The other feature of Harris's proposal that differs from Trump is an income limit for eligibility. While we don't know what that income limit would actually be, it's another safeguard from high earners exploiting the exemption for their own gain. Let's get into some of the nitty-gritty of why tax experts don't think this is a good policy. The first criticism is about eligibility. Experts say even without accounting for any potential income limits, the tax advantage would still only go to

a sliver of the already small tipped worker population. That's largely because about one third of these workers don't earn enough to owe federal income taxes anyway. Another criticism of the plan has to do with access to other tax benefits. Now, neither candidate has specified whether tips would be exempt from both the federal income tax and the federal payroll tax, but Senator Ted Cruz's bill does not apply to the federal payroll tax. Speculatively speaking, it's hard to see Kamala applying her proposal to the payroll tax if Ted Cruz isn't. And that's a good thing, because the payroll tax is something both workers and

employers pay into in order to both fund and benefit from Social Security and Medicare. Exactly. But there are two tax credits that a no-tax-on-TIPS policy could jeopardize, the earned income tax credit and the child care tax credit. This all depends on how the law is written, but those credits vary depending on your earned income, so reducing earned income on taxes could reduce benefits. Anna, let's turn now to how no tax on tips could affect non-tipped workers, bosses, and consumers. Yeah, experts are concerned that a tax exemption that goes to a very specific group of people could fuel resentment among other workers, particularly those in similarly lower-wage fields. As David Cooper, a researcher from the nonpartisan research and advocacy organization EPI Action, told me when I was researching the story, quote, why would we be giving preferential income tax treatment to

this very small subset of workers when there are lots of other hardworking, low-paid workers, people providing daycare, childcare, elder care, that this would do nothing for. Meanwhile, consumers could go frustrated too. There have been countless reports of tipping backlash and tipping fatigue as we're asked to tip more than ever in situations that you normally wouldn't expect. Again, consumers could perceive this tax advantage as unfair, even if only a small group of workers are eligible, and tip even less than they already do as a result. In case you don't know this, listeners, the U.S. is one of the few countries in which tipping is a norm. A big reason why it persists is because it benefits businesses.

They don't have to pay their employees as much as they would for other work. That's because consumers bear the brunt of paying workers through tipping. So a tax advantage could be a way to both attract workers to tipped positions and yet another incentive for bosses not to increase wages for tipped workers. Listeners, as you've heard, critics have a lot of gripes with a no-tax-on-tips policy, no matter who proposed it. So what's a better policy? They say eliminating the sub-minimum wage and raising the minimum wage. It's clear those are not keeping apace with inflation. Agreed. They also said that some other levers that could help workers would be expanding income supports like the child tax credit, earned tax credit, and

Medicaid. Just so listeners know, changing the minimum wage or the tax code requires action from Congress. Trump and Harris's economic policy plans are still shaping up, so we'll have to see if there's more detail to come about the no-tax-on-TIPS policies in the coming months. Up next, a few money headlines in the last few days. Sean, it seems like just a couple of weeks ago that the word recession started appearing everywhere again. That's because it was. Right. The Dow dropped a thousand points in a day because of a worse than expected jobs report. And just like that, a possible recession was back in the spotlight. And then within a few days, the market started recovering and we got

another indicator that said, hey, maybe things aren't so bad. And those indicators keep coming. Now, nobody's saying there's no chance for recession. How's that for a double negative? But last week's Consumer Price Index showed inflation heading in the right direction for a Fed rate cut. Yeah, this important measure of inflation dropped to 2.9% year over year in July, down ever so slightly from June's 3%. It's the first time the CPI has been below 3% since 2021. Meantime, the Commerce Department reported that retail sales rose 1% in July, the biggest jump in more than two years. We are spendaholics. We are, at least this summer.

Spending on everything from cars to furniture to appliances rose, as it did with groceries, electronics, and more. Yeah, restaurants and bars too, up 3.4% from July of last year. Maybe it's some nice alfresco dining. Yeah, Aperol spritzes for everyone. We mentioned car sales, and indeed, that was a bright spot in consumer spending in July. Economists say part of that was pent-up demand after a cyber attack affected dealerships across the country in June, but it could also owe to an increase in new vehicle sales incentives. Yeah, Kelley Blue Book reports that prices were lower year over year in July for the 10th

consecutive month. The average price of a new car was $48,401, which still ain't cheap, but that's down just over 3% from a peak in December 2022 of just under $50,000. Dealership incentives and higher inventory are bringing those costs down, but you're still paying a lot more in interest than you were, say, three years ago. Also, $48,000 average for a car. That's a lot of scratch. It is, but we Americans love our cars. One good way to bring that price down for yourself is to buy used and those prices are dropping big time. Cox automotive says average wholesale prices for used cars fell 8.9% in June versus June of 2023. That's 22 consecutive months of price drops for used cars. And in case you've been holding off on buying a car because you're not sure if you can afford one yet, check out NerdWallet's Car

Affordability Calculator. It's free to use and calculating how much car you can afford before you visit the dealership can save you hundreds, maybe even thousands of dollars in the long run. We'll link to the calculator in today's show notes or just search online for NerdWallet Car Affordability Calculator. And Sean, let's finish off with one more news item about prices. Ring it up. The grocery giant Kroger is promising that if its $25 billion merger with Albertsons is approved by regulators, it will cut grocery prices by $1 billion. Yeah, that's an attempt to assuage critics of the merger who say it will lead

to higher costs for consumers. If the merger goes through, it would create the second largest grocery chain in the country. But it's got more than a few hurdles to clear before that happens, including a Federal Trade Commission trial and multiple lawsuits. Legal help clean up in aisle four. That's it for this week's Money News. We always welcome your money questions and comments. Turn to the nerds and call or text us your questions at 901-730-6373. That's 901-730-NERD.

Or send us a voice memo at podcast at nerdwallet.com. And remember, you can follow the show on your favorite podcast app, including Spotify, Apple Podcast time, turn to the nerds.