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Tax-free tips might not actually help intended workers, and could increase the U.S. deficit

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Tipping for services apparently is misunderstood, which helps explain why it sparks resentment in some customers, including some of my own family members, I’m sad to say.

So I thought I give unemotional artificial intelligence a shot at explaining it. Here’s what ChatGPT says about tipping.

Tipping for services typically refers to giving an additional amount of money to service providers, such as waitstaff in restaurants, hairdressers, taxi drivers, or hotel staff, as a token of appreciation for their service. Tipping customs vary widely by country and culture, but it's generally seen as a way to acknowledge good service or to supplement lower wages in industries where tipping is customary. Tipping amounts often range from 15% to 20% of the total bill in places like restaurants, though this can vary. It's a social practice that aims to reward good service and is often discretionary rather than mandatory.

Ah, but even AI misses a key point, especially when it comes to tipping restaurant servers.

Wage law for tipped workers: Federal law says an employer of a tipped employee, who is described as someone who regularly receives more than $30 per month in tips, generally is only required to pay $2.13 per hour in direct wages if that amount plus the worker’s tips at least equals the federal minimum wage. The federal minimum wage is [still] $7.25 per hour.

If a tipped employee's tips combined with the employer's direct wages of at least $2.13 per hour do not equal the federal minimum hourly wage, the employer must make up the difference. Many states, however, require higher direct wage amounts for tipped employees.

So basically, tipped workers’ minimum wage is in reality $2.13 an hour.

That means that your tip to your server is not necessarily over the minimum wage amount, but helps bring that worker’s income to the full minimum wage level.

New tax-free tips legislation: Which bring us to the presumptive Republican presidential nominee’s recent proposal to exempt tips from federal taxation. Donald J. Trump tossed out that idea during a campaign stop in Las Vegas, Nevada, a city full of people whose jobs include tips.

Naturally, GOP lawmakers jumped right on the proposal, which is not new.

Tax-free tips has been floated before. Sen. Rand Paul (R-Kentucky) proposed the same tax break during his 2014 presidential run. Like Trump, he announced the prospect at a Las Vegas campaign stop.

Paul’s proposal went about as far as his attempt to win the Oval Office, which is to say nowhere. But lawmakers love their soundbites and the attention they garner.

Current GOP members also love getting on Trump's good side. So, it’s also no surprise that a couple of lawmakers jumped on Trump’s promise that making tips nontaxable would be the “first thing” he does if reelected.

Republican Reps. Matt Gaetz of (Florida and Thomas Massie of Kentucky have introduced Tax Free Tips Act of 2024. The bill solves the legislative hurdle Trump’s promise posed; it would properly follow legislative requirement that Congress, not the executive branch, create tax law.

The Tax Free Tips Act, introduced on June 18 and pending the House Ways and Means Committee, would allow tipped workers to “keep every dollar of tip money they earn,” Gaetz said in a statement. “Taxing tips is regressive and goes against American tradition,” added Massie.

Under the Gaetz-Massie bill, tips would be treated as “property transferred by gift” rather than as wages. As such, they would be exempted from payroll withholding, and Social Security and unemployment taxes.

The Tax Free Tips Act also is the first of this weekend’s three Saturday Shout Outs.

Tax-free tips could hurt instead of help: The second shout goes out to Howard Gleckman, a tax policy expert who doesn’t think tax-free tips are good tax policy. Gleckman, a Senior Fellow at the Tax Policy Institute, also explains in his post for the nonprofit’s TaxVox blog “Why Trump’s Tax Cut Promise Would Hurt Many Service Workers.”

“Tax-free tips might help a relatively small number of waiters at high-end restaurants. And they could reward hotel owners such as Trump by slowing efforts to raise the minimum wage for tipped workers. But many tipped workers make so little income that they already pay little or no income tax,” notes Gleckman.

And perhaps even more important, writes Gleckman, “repealing taxes on tips also could take the steam out of efforts to raise the cash minimum wage for tipped workers.” Raising it, you’ll recall, from the appallingly low $2.13 per hour.

Budget problems possible: Finally, a third shout out goes to the Committee for a Responsible Federal Budget. The Washington, D.C.-based nonpartisan nonprofit that focuses issues with significant fiscal policy impact says that “Donald Trump’s Proposal to Exempt Tip Income from Federal Taxes” would reduce federal revenues by $150 to $250 billion over ten years on a static basis.

Once behavioral effects are incorporated, say CRFB, the revenue reducing effects could be significantly more. For example, exempting tip income from taxation could lead workers and employers to reclassify ordinary income as tip income where possible, and could lead to a larger shift toward lower base pay and higher tipped income, more broadly.

“As an illustrative example, if tips were increased by 10 percent, the policy would reduce revenue by $165 to $275 billion, and if they doubled it would increase deficits by $300 to $500 billion,” according to CRFB calculations.

All these shouts show that Trump’s promise to a group of tip-receiving voters in a crucial swing state for the upcoming presidential nomination still has a long way to go. Given the political, fiscal, and social ramifications, the path to a tax-free tip reality is, at best, murky.

So, keep tipping, knowing that it’s not just add-on money for most workers. (Yes, I am looking at you, my stingy family members.) Our gratuities help these tip-receiving employees get the barest of minimum wage in most cases.

And if you do get tips on your job, remember that until they are tax free, you still need to report them to your employer when the monthly amount exceeds $20.

Finally, here's one last tipping tip. Apparently, it also works on AI. One X (formerly Twitter) poster found that offering ChatGPT  a tip produced longer responses.   

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