I spent my high school years working at Allen’s Clam House, an unpretentious but not inexpensive seafood restaurant in Westport, Connecticut. I began as a dishwasher, moved on to be a fry cook, and spent a few ill-advised shifts working in the dining room as a busboy.
I was bad at table service: too many competing demands from too many irritated people. The customers were a big part of the problem, asking for things that I couldn’t deliver fast enough. But so were the waiters, who had their own list of expectations.
The waitstaff at Allen’s were professional but could be short-tempered when faced with a subpar busboy. Many of these waiters had been working in restaurants for decades, and some traveled seasonally, spending the summers in Connecticut and winters in Florida.
And most of them made a decent living. As I said, Allen’s was not cheap, and tips could be substantial. Almost as important, the tax treatment of these tips was very generous. Waitstaff were required, of course, to report their tips as income. But based on what I heard at Allen’s, underreporting was routine.
Until 1982 it was routine, at least. That’s when a try-hard, killjoy Kansas senator, Bob Dole, convinced congressional colleagues to get serious about taxing tipped workers. The time had come, he insisted, to tax waiters on their actual income — or at least something more nearly approximating it.
The waiters at Allen’s responded to this effort with incredulous outrage. Pay taxes? On our tips? Really?
Election Imperatives
I was reminded of this episode while contemplating this year’s campaign proposals to undo Dole’s good work from the Reagan era. In a rare display of bipartisan groupthink, Donald Trump and Kamala Harris have agreed on the need to win Nevada’s six electoral votes — I mean, on the economic and moral necessity of exempting tips from taxation.
Trump and Harris seem to disagree on the details of their vote-buying schemes. Trump has signaled plans for an expansive and comprehensive exclusion, available to all workers and possibly extending to payroll as well as income taxes. Harris seems to favor a more limited version of the idea, restricting the exclusion to workers in the service and hospitality industries and providing for both an income limit and a cap on the amount of the excludable income.
Members of Congress have jumped on these similar but competing bandwagons, introducing a range of bills that differ on key details but agree on the need to stop taxing tips. Some measures reflect a broad approach, consistent with Trump’s expansive plan to completely eliminate the taxation of tips; others feature income limits and caps on the amount that can be deducted by a taxpayer.
Nevada lawmakers have been visible champions of the tip legislation in both chambers. As my colleague Cady Stanton pointed out recently, “Nevada has the highest concentration of waiters and waitresses by state in the country, according to the Bureau of Labor Statistics.” It’s no surprise, given that large constituency, that Nevada lawmakers find much to like in plans to untax tips.
On the other hand, tax experts hate everything about these proposals. Steve Rosenthal of the Urban-Brookings Tax Policy Center spoke for many with his list of complaints. “In tax policy, we evaluate proposed reforms by how well they promote equity, efficiency, and revenue,” he wrote in a recent piece for Forbes. “‘No taxes on tips’ fails all three tests by singling out certain taxpayers for relief but not others similarly situated; distorting compensation arrangements and labor markets; and losing substantial revenue, potentially hundreds of billions of dollars in the first 10 years.”
One of the worst things about the tax-free tip proposals is how ineffective they would be at actually helping tipped workers. The Budget Lab at Yale University noted in a recent report that “about 4 percent of families report tips to the IRS, and those who do are disproportionately young, unmarried, and lower-income. This means that many tipped workers do not pay income tax to begin with and would not benefit from a new deduction.”
Indeed, the Budget Lab estimated that fewer than 3 percent of families would see any benefit from a tax deduction for tips. And the benefit would be smallest for those who earned the least: In 2026, the lab said, “the average tax cut for families who benefit would be roughly $1,700, though for bottom-quintile families that number is just $200.”
Such facts are inconvenient for those who want to end the federal taxation of tips. They are also immaterial, at least in political terms. The idea of untaxing tips is very popular, and not just in Nevada. A recent Ipsos survey found that roughly three-quarters of Americans like the idea. Even more striking, support was basically uniform across the political spectrum; 73 percent of Republicans liked it, as did 75 percent of Democrats and 73 percent of independents.
What explains this popularity? It’s possible that voters will embrace anything that sounds like a tax cut, especially when it’s focused on the nonrich. They even seem willing to set aside doubts about its efficacy. In the Ipsos survey, just 54 percent of respondents said they expected the tip proposal to increase the financial security of tipped workers. Likewise, 43 percent said that employers would probably undercut the tax benefit by finding ways to reduce worker pay.
Outrage in the ‘80s
A little history can also illuminate today’s rush to exempt tips from taxation. The waiters at Allen’s Clam House in 1982 weren’t the only ones upset by the crackdown that year on underreported tips. As law professor Joel Newman recounted in a 1988 article for Tax Notes, indignant outrage was in ample supply.
This chapter in tax history began when Congress decided to get tough with tax-avoiding waitstaff. As part of the 1982 Tax Equity and Fiscal Responsibility Act, large restaurants were required to report taxable tips for their employees, regardless of whether those tips had actually been received by servers.
As Newman explained in “Waiter, There’s an IRS Agent in My Soup,” the IRS would presume that workers had earned tips at a rate of 8 percent. If the total of all tips reported by waitstaff in a restaurant did not equal or exceed 8 percent, the deficiency would be allocated among the tipped employees and reported to the IRS.
This provision appeared during legislative wrangling over TEFRA, and it almost died when the Senate voted to delete it during floor debate. But Dole, the Finance Committee chair, saved the proposal with some clever horse-trading. During negotiations with the House over a conference bill, Dole agreed to drop an unpopular limit on business meal deductions in exchange for a restoration of the tip provision. He had added the deduction limit to the bill with exactly this sort of trade in mind, according to Newman.
In short order, the IRS quickly promulgated temporary regulations. And predictably, unhappy waiters deluged the agency with angry letters. “In January 1983, a flood of commentary began to arrive,” Newman recounted. “Even compared to other issues which generated a large volume of commentary from individual taxpayers, these comments were unique. The letters were long, handwritten, and very angry.”
Many of the letter writers were incredulous, insisting that tips were actually tax-free gifts. (As I recall, that was the prevailing sentiment at Allen’s Clam House, too.) After decades of underenforcement by the IRS, waiters had come to believe that this view of tips was all but universal; tax-free tips were a right, they believed, even if lawmakers were claiming otherwise.
Newman quoted some of the more colorful complaints drawn from the comment letters. Here are a few:
- “You’ll have all of us on welfare if you keep this up, but then maybe that’s what you want. Then you could really be in control, just like the Russians.”
- “The IRS is always looking for ways to screw the poor people.”
- “If your act stays in effect good luck next time you dine. It will probably be cafeteria style. Who can afford to be a waitress? If it isn’t cafeteria there may be a very hot, steaming bowl of soup fall on your lap next time you do dine. That’s the only kind of help that will be available.”
- “If the President wouldn’t have screwed the economy up so bad you wouldn’t need to tax our tips. You didn’t need them before. You shouldn’t need them now. The whole thing sucks.”
- “Shame, shame, how do you sleep at night.”
The anger in these letters seems genuine. Waiters weren’t simply unhappy that they were being asked to pay more taxes, although that was certainly the proximate cause of their unhappiness.
They also harbored a sense of betrayal and injustice, both bred by decades of underenforcement. Since the 1960s, Congress and the IRS had been looking for ways to bolster collections on tipped income. But the chronic failure of these efforts had bred a sense of entitlement.
Customary Deviations
In a 2012 article, “Custom and the Rule of Law in the Administration of the Income Tax,” Duke law professor Lawrence Zelenak observed that poor enforcement of one law may encourage a more general disrespect for the law. “For example,” he wrote, “the ability of tipped workers to avoid paying tax on a substantial portion of their tips may contribute to a general decline in voluntary compliance.”
Zelenak distinguished the pernicious effects of underenforcement from a different phenomenon, which he called “customary deviations” — established practices on the part of tax administrators that deviate from the clear dictates of the Internal Revenue Code. “Customary deviations are always protaxpayer,” he wrote, “for the simple reason that taxpayers could and would successfully challenge in court any administrative attempt to deviate from the statute in an antitaxpayer direction.” Zelenak cited the favorable treatment of frequent flyer miles earned by business travelers as an obvious example of this phenomenon.
Zelenak’s distinction between poor enforcement and customary deviations seems reasonable. But it’s also easy to overdraw. Sometimes, lax enforcement and a customary deviation can produce similar results, including a sense of entitlement among taxpayers.
That seems to have been the case with tips and taxes. After decades of lax enforcement, many waiters in 1983 had come to view tax-free tips as a matter of right. That sense of entitlement pervaded their complaints. These servers were angry that someone was trying to change the rules of the game — rules they believed were legitimate and implicitly sanctioned by past practice.
Deliberate Deviation
This year’s promises to untax tips would be a formal deviation, both from recent history and from sound policy. As countless experts have already pointed out, eliminating the tax on tips is indefensible as a matter of theory; tips are clearly income, as the law defines the term, and just as clearly income in an economic sense. Such provisions are also indefensible as a matter of practice, since they wouldn’t deliver much help to the people who need it most.
But the idea of tax-free tips seems to be enduringly popular. As Rosenthal pointed out, this year’s rush to exclusion isn’t a new idea; Rep. Ron Paul floated the same sort of proposal during his 2012 campaign for the GOP presidential nomination.
Paul’s idea disappeared along with his candidacy, and Rosenthal seems hopeful that something similar will happen this year. “Maybe Trump’s and Harris’s proposals will expire with their campaigns, just like Ron Paul’s proposal did,” he wrote. “For tax policy’s sake, let’s hope what happens in Vegas stays in Vegas.”
We can hope, but I wouldn’t bet on it. This idea keeps turning up like a bad penny. And voters seem OK with that.
Read the full article here
