Eliminating Taxes on Tips: Is It a Viable Plan?

Why are presidential candidates suddenly interested in making tips tax-free? What potential problems could arise from eliminating taxes on gratuities?

Both Donald Trump and Kamala Harris proposed eliminating taxes on tips as part of their 2024 campaign platforms. Their proposals aim to increase take-home pay for millions of service industry workers, but economists warn of significant challenges and potential consequences.

Keep reading to discover the complex implications of eliminating taxes on tips and how this policy could affect workers, businesses, and the broader economy.

Eliminating Taxes on Tips

In a rare moment of policy alignment, 2024 presidential candidates Donald Trump and Kamala Harris both promoted a controversial idea: making tips tax-free. But this seemingly worker-friendly proposal has economists and policy experts raising red flags. While the idea might appeal to many voters, economists warn that eliminating taxes on tips could cost the government up to $250 billion in lost revenue over a decade and lead to potential abuse of the system. Also, implementation challenges—including IRS enforcement and shifts in tipping behavior—could undermine the benefits of such tax exemptions.

We’ll examine experts’ views on the matter.

Background

Under current IRS rules, all forms of tips—whether cash, electronic, or nonmonetary—are subject to federal income tax. Workers must inform their employers of cash tips totaling more than $20 per month, while employers are responsible for deducting income, Social Security, and Medicare taxes from both wages and reported tips. In 2018, over six million workers paid taxes on $38 billion in tips, averaging more than $6,000 per worker who reported their tips.

It’s within this context that former president Donald Trump and Vice President Kamala Harris proposed changes to tip taxation. Their plans aim to benefit service industry workers who rely heavily on tips, potentially increasing take-home pay for millions of restaurant servers, bartenders, hotel staff, and others.

Trump and Harris’ Plans

Both Trump and Harris introduced their plans while campaigning in Nevada, a key swing state with a large service industry workforce. However, experts say that neither Trump nor Harris provided specifics about how they would implement or fund their plans or how the government would make up for the potential tax revenue loss.

Trump first introduced the idea of ending taxes on tips in June 2024. He has since promoted it at campaign events, promising voters that, if reelected, “We are going to let you keep 100% of your tip income and not be harassed.” He’s also said his plan would go “full bore,” exempting tips from both income and payroll taxes.

Harris unveiled her proposal in early August 2024. Her campaign said she would couple the tip tax exemption with a minimum wage hike. It would also include income limits and strict requirements to prevent high-earning professionals from exploiting the tax break by reclassifying their pay as tips. Unlike Trump’s plan, Harris’ proposal would still subject tips to payroll taxes, which fund programs such as Social Security and Medicare.  

Potential Impact and Criticisms

While the candidates’ no-tax-on-tips proposals aim to benefit service workers, economists and policy analysts have raised several concerns about them.

Economic and Fiscal Impact:

• The plan could cost the government between $100 billion and $250 billion in lost tax revenue over a decade.
• Its benefits would be limited, with just 4 million workers (2.5% of employment) in tipped occupations, many of whom already paying little to no federal income tax because their earnings are too low.
• Some tipped workers could lose eligibility for the earned income tax credit or accrue less credit toward Social Security benefits.

System Manipulation and Fairness:

• The policy could incentivize workers to shift towards tip-based income and employers to restructure pay systems. This could lead to widespread changes in compensation and industry practices and expand beyond restaurants to other sectors—such as finance, sales, or freelance work—broadly reducing individual income tax and company payroll tax contributions.  
• High-income individuals such as hedge fund managers or lawyers could exploit the system by reclassifying wages or profits as tips to take advantage of the tax break.
• The plan could create disparities between tipped and non-tipped workers earning similar incomes.

Implementation Challenges:

• The IRS could have difficulty enforcing the policy, particularly preventing abuse such as high-earning professionals agreeing to “tips” in advance for their services to avoid taxes.
• Some customers, knowing that gratuities aren’t taxed, might reduce the amount they tip, potentially offsetting workers’ gains. 

Given these concerns, some labor advocates argue that other policies could better address financial hardships that service workers face.

Looking Ahead

Congressional approval is necessary for any tax legislation changes, which could face hurdles. However, the idea of eliminating taxes on tips has garnered bipartisan support, with some Republican senators already proposing legislation such as the No Tax on Tips Act. The expiration of Trump’s 2017 tax cuts in 2025 could also provide an opportunity to introduce new tax policies.  

Given economists and policy analysts’ concerns about exempting tips from taxes, alternative approaches could gain traction. Some experts recommend a broader solution: Increase the amount of income all workers can earn before owing federal income tax. This approach would allow more workers to keep a larger portion of their earnings tax-free, benefiting low- and middle-income workers across all occupations, not just those in tipped positions. It could also avoid some of the potential pitfalls of a tip-specific tax exemption.

Reflection & Discussion Questions

1. How might eliminating tax on tips affect different sectors of the service industry differently, and which workers would benefit the most from this policy?
2. Given the historical connection between tipping and racial inequality in America, how should this context inform current policy discussions about tip taxation?
3. What alternative solutions could better address the financial challenges of service industry workers while avoiding the potential pitfalls of tax-free tips?
4. How might consumer tipping behavior change if people know their tips aren’t being taxed, and what impact could this have on service workers’ total income?
5. Should high-earning professionals in fields like finance and law be prevented from reclassifying their income as tips? If so, how could this be effectively regulated?
6. How does the projected $250 billion in lost tax revenue over a decade compare to other federal expenses and tax breaks, and what programs might be affected by this loss?

Want to fast-track your learning? With Shortform, you’ll gain insights you won't find anywhere else .

Here's what you’ll get when you sign up for Shortform :

• Complicated ideas explained in simple and concise ways
• Smart analysis that connects what you’re reading to other key concepts
• Writing with zero fluff because we know how important your time is

Start your free trial today!