The Case for No Tax on Tips: Economic and Social Benefits

Taxing tips has long been a contentious issue in the United States, with issues centered on fairness, working conditions, and economic development. Many service workers, such as waiters, bartenders, and delivery drivers, rely heavily on tips, which are currently covered by federal and state income taxes. This article examines the rationale for eliminating tip taxes, analyzes their potential impact on employees, businesses, and government revenues, and examines counterarguments.

1. Current Tip Tax in the United States

Under current IRS regulations:

Tips are taxable and reportable to employees.

Employers must report tips (via Form 4070) and withhold payroll taxes.

The federal minimum wage with tips is **$2.13/hour** (as of 1991), assuming tips cover the gap to the standard

$2.13/hour∗∗ (as of 1991), assuming tips cover the gap to the standard minimum wage of $7.25/hour.

Drawbacks of the current system:

Underreporting: Many strategies go unreported due to tax issues or tax avoidance.

Low base pay: Tipped workers often face income volatility.

Double taxation: Some states offer tax breaks even if they don’t meet the minimum wage threshold.

2. Issues for eliminating tip taxes

A. Increase the real wages of low-wage workers

Tipped workers earn $27,000 per year (BLS 2023), which is below the U.S. median.

Tax-free strategies can increase your profits by 15-25% (depending on your tax rate).

For example: A server earning $30,000 in tips could save $30,000 in tips, potentially saving $3,000-5,000 per year** (assuming an effective tax rate of 10-20%).

B. Reduce administrative burden

Eliminating the tip tax would speed up payroll for 1.3 million U.S. hospitality businesses.

The IRS spends millions on tip compliance audits; improvements could reduce implementation costs.

C. Encourage honest reporting

If tips are tax-deductible, employees would have no incentive to under-report them, increasing transparency with the IRS.

D. Stimulate the local economy

Low-wage workers spend ~90% of their immediate income (Brookings Institution).

High disposable income → high demand for goods/services in their respective areas.

E. Reconcile other untaxed income

Like tax-deductible gifts (under $18,000 per year) or special benefits, tips can be reclassified as “tips” rather than wages.

3. Economic consequences

A. Government revenue loss: excessive?

The IRS estimates $11 billion per year in unreported tips (Treasury Department, 2021).

If tips were not taxed, the net revenue loss could be $5-8 billion per year (after accounting for compliance improvements).

For context, that’s <0.2% of total federal revenue ($4.9 trillion in 2024).

B. Business Benefits

Restaurants/bars could attract workers without raising base wages.

Reduced operating income: Higher real wages can improve retention in industries with an average annual turnover of 75% (TDn2K).

C. You are inflation neutral

Unlike general wage increases, tax-free strategies will not force businesses to raise prices.

4. Reasons against the deduction

A. “The loss of tax revenue will impact public services.”

Disclaimer: The system could pay for itself through reduced implementation costs and economic growth.

B. “Only certain employees benefit.”

Disclaimer: While 14% of American workers rely on tips (Pew Research), they receive disproportionately little.

C. “Can encourage tip pooling abuse.”

Solution: Combine tax exemptions with strong labor laws (e.g., banning mandatory executive bonuses).

5. Legal precedents and recommendations

Trump’s 2024 proposal: Called for tax exemptions for tips, but lacked legal detail.

National actions:

In Nevada, tips are taxable, but offset by the lack of a state income tax.

There is no income tax in Florida (tips are still subject to federal tax).

H.R. 2129 (Tipping Tax Fairness Act): A bill to exempt tips from the tax in 2023; stuck in committee.

6. International Comparison

Canada: Tips are not taxable if paid in cash

Expanding on the Impact for Workers and Businesses

Eliminating taxes on tips would provide immediate financial relief to millions of service workers, many of whom live paycheck to paycheck. For example, a bartender earning

40,000 annually(40,000annually(20,000 in wages + 20,000 in tips)could see their

∗(effective tax rate drop from 20,000intips)couldseetheir∗∗effectivetaxratedropfrom122,400/year**—equivalent to a month’s rent in many cities. This extra income could reduce reliance on public assistance programs like SNAP or Medicaid, indirectly lowering government spending.

For businesses, particularly small restaurants operating on thin margins (3–5% average net profit, per the NRA), tax-free tips could serve as a low-cost retention tool. A 2023 survey by Toast found that 68% of servers would prioritize employers who maximize take-home pay. Notably, this reform wouldn’t require businesses to raise wages, unlike minimum wage hikes that strain operators.

However, critics argue that exempting tips might discourage employers from paying living wages, perpetuating reliance on customer generosity. To mitigate this, Congress could tie the policy to a phased increase in the tipped minimum wage, ensuring a balanced approach.