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Unintended Consequences

I love the idea of no taxes on tips…or social security…or really any income. After all, almost all income is derived from work or investment. Why should we punish these obvious benefits to society? The no-tax-on-tips change is especially appealing politically since jobs that earn tips normally are not amoung the higher paid ones, so both major political parties can pretend they care about the working class by supporting the change.

Unfortunately, like so many things that government messes with, what sounds good will always have unintended consequences. People always change their behavior when tax law changes. The market always adjusts. Think about how eliminating taxes on tips would change the environment. First of all, you’d be giving a 12-24% take-home pay increase to service workers (depending on tax bracket), which means there would be more incentive to stay in those jobs rather than seek new careers. Plus, people who weren’t interested in such jobs may now reconsider. The result is hospitality businesses have more workers to choose from and can therefore find ways to pay less…for example, fewer benefits, elimination of free-meal perks, or a reduced hourly base rate (before tips). When I worked as a waiter many years ago, we were paid $2 per hour plus tips, which really sucked during shifts such as 1-5pm when few customers came in. Could management now eliminate the base rate altogether? If they did, local governments would likely jump in to mandate a certain base rate if they haven’t already, but that just means service businesses must pay a higher-than-market wage rate, which would result in higher prices and more automation. You also would have other businesses trying to change pay structures altogether, creating new jobs where tips are a part of wages. And you think you have tipping fatigue now?!

You’d likely need whole new sections of the tax code to even define what is a tip. If this follows the pattern of current tax law, the IRS will probably create a bulleted list of “tests” that must be met; for example, 1) Business is in a service industry, not including xxxx industries. 2) Taxpayer is receiving wages in a job where tips are customary. 3) Base wage rate must be xxxx percent of median income according to Bureau of Labor Statistics (see table 450). And so on. Then, you’d get more audits, appeals, tax court challenges, and the usual bureacracy. It may even add another volume to the tax code.

The point is whenever government gets involved, there are always foreseen and unforeseen consequences that mess with market dynamics and introduce unnecessary, inefficient complexity. As much as I’d love to see service workers get more take-home pay, this change may not be as celebratory of an event as we expect. The only real solution is to get government out of the business of taxing income altogether.

Senate passes the No Tax on Tips Act in a unanimous vote

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