Trump and Harris embrace ‘no tax on tips’ proposal. But tax experts say it’s a bad idea

For months, former President Donald Trump has touted a simple, four-word proposal as part of his campaign: “No tax on tips.”

Under his plan, restaurant workers, barbers, caddies, movers, drivers and others would not be taxed on their tip income.

Recently, Vice President Kamala Harris followed suit, pledging to eliminate taxes on tips for hospitality and service workers if she wins in November.

But, despite having the support of both campaigns, the plan to remove taxes on tip income is a bad one, according to tax experts.

“It is unfair, inefficient and will add unneeded complexity to the already very complex tax code,” Sanjay Gupta, a professor of accounting at Michigan State University’s Broad College of Business, told McClatchy News.

Downsides to ‘no tax on tips’

One of the chief criticisms of the proposal is that it is prejudicial, arbitrarily offering tax exempt status for a sliver of the workforce, while leaving out the rest, experts said.

“There isn’t a good reason why tipped workers need tax relief but other low- to- moderate-income workers do not,” Alex Muresianu, a senior policy analyst at the Tax Foundation, a think tank in Washington, D.C., told McClatchy News.

Upward of 95% of low-to-moderate income workers do not receive tips, meaning they would not benefit from the initiative, Brendan Duke, the senior director of economic policy at the Center for American Progress, a left-leaning think tank, wrote in a July article about a “no tax on tips” bill proposed in the Senate.

The plan is even unfair to some members of the restaurant industry, where tip income is most common, Gupta said.

For example, fast food employees — in contrast to servers at sit-down restaurants — earn the majority of their income in the form of hourly pay and typically do not receive tips.

“How is it fair for restaurant wait-staff to have a portion of their wages exempt from tax whereas the fast food restaurant workers to not get such an exemption?” Gupta said.

The “no tax on tips” plan is also seen as an inefficient way to reduce taxation because many of those who rely on tips would not qualify, experts said.

It is not “well-targeted” because “a substantial chunk of tipped workers earn below the standard deduction already, which means they currently do not pay personal income taxes,” Muresianu said.

So, the proposal — if enacted into legislation — would mostly benefit higher earning service industry workers, like those at expensive restaurants and luxury hotels, Gupta said.

Even then, the tax cuts would be miniscule, Duke said.

Further, the plan would complicate the already Byzantine tax code, leading to questions about what kinds of tips are exempt, Gupta said.

“Which tips will be excluded from taxable income - only cash tips or all tips?” Gupta said. “Which taxes would the tip income be exempt from - federal income taxes only or payroll taxes as well?”

By adding an additional layer of complexity to the tax system, it could also create loopholes for “tax games,” Muresianu said.

The Senate bill, for example, “contains few, if any, guardrails to prevent high-income professionals such as hedge fund managers from shifting their compensation to a tax-free tipping model,” Duke said.

Harris’ campaign plans to address some of these issues, privately telling reporters that she would consider capping the exemption for workers earning more than $75,000 annually, according to the Washington Post. And while her plan would shield tip income from federal income tax, it would not affect payroll taxes.

Better ways to reduce taxes

Still, experts said, there are numerous other ways to ease the tax burden on low-to-middle income earners that are simpler and fairer.

For example, the standard deduction —the amount that can be subtracted from income before tax – could be increased, both Gupta and Muresianu said.

This would “apply to all taxpayers, regardless of the type of income,” Gupta said.

Other options include expanding the Earned Income Tax Credit or reducing the payroll tax, Muresianu said.

The tax rate for lower income tax brackets could also be brought down, Gupta said, adding “such measures will be less distortionary and less complex.”

“In short,” he concluded, “candidates should be very mindful in proposing tax policies that are fair, efficient and simple to implement.”

This story was originally published August 28, 2024 at 11:35 AM with the headline "Trump and Harris embrace ‘no tax on tips’ proposal. But tax experts say it’s a bad idea."