Here’s A Tip:‘No Taxes On Tips’ May Be Good Politics But Is Bad Policy

In Las Vegas this summer, both Republican presidential nominee Donald Trump and Democratic presidential nominee Kamala Harris vowed to end the taxation of tips. It's not a new idea: A dozen years ago in the same city, Republican presidential candidate Ron Paul proposed it, too.

In the frenzy of a presidential campaign, these Vegas vows on tax policy make political sense, especially given battleground state Nevada's large number of employees in the hospitality and leisure industry .

But the bipartisan "no taxes on tips" proposal is the most prominent example of a politically attractive soundbite bumping aside sound policy. ( Exempting overtime pay from taxation is another example, raised recently by Trump and rejected by Harris.)

Don't get me wrong. Low-wage workers, including tipped employees, deserve our attention. Their incomes can fluctuate widely , often just one child's illness or broken-down car away from economic ruin . But, as my TPC colleague Howard Gleckman observed , encouraging tips could exacerbate their financial woes, substituting unpredictable largesse for steady wages. And exempting tips from tax may not help, as TPC estimates that more than 40 percent these workers will not benefit, because they pay no income taxes.

(The exemption proposed by Vice President Harris is only from federal income tax, while the vaguer plan of former President Donald Trump may cover payroll taxes as well. If Trump intends that no Social Security taxes be withheld from tips, his plan could threaten the retirement security of tipped workers.)

I spent years on Capitol Hill, often helping to craft tax rules to advance economic and social goals. In the decades following in private practice, I advised clients how to use tax rules effectively.

These experiences taught me that Congress's best-laid tax plans too often go awry.

In tax policy, we evaluate proposed reforms by how well they promote equity, efficiency, and revenue. "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.

Favoring compensation by economic sector or geography makes little sense. It's not fair to subsidize Le Cirque waiters but not McDonald's customer service associates with tax-free tips. Or to so favor a hotel's housekeeper, but not a homeowner's house cleaner. Or, for that matter, traditional employees and not independent contractors in the growing gig economy.

Tax free tips also would distort compensation arrangements and labor markets. Non-tipped workers might start demanding tips—such as landscapers, plumbers, auto mechanics, grocery tellers, dental hygienists, and others. Or they could abandon their jobs for tipped employment. This could result in a surplus of restaurant waiters and a shortage of fast-food cashiers, abundance of bartenders and not enough warehouse workers, or too many food deliverers and too few package deliverers.

Meanwhile, consumers frustrated already by the recent explosion of tip requests might find many more payment pads with tip instructions thrust at them when time comes to settle up. If discretionary tips replace fixed wages, then the labor market would be less transparent, less certain, and less efficient.

Very few tax rules fully and consistently align public and private objectives. The fundamental problem is that when Congress drafts tax rules, it often misses those it wants to help—and helps those it wants to miss. The consequences of these misfires are usually small, but sometimes, as in the case of ending the taxation of tips, they could be huge, encouraging millions of workers to game the tax system.

So why risk it when there are so many ways to help all low-wage workers more effectively? These include raising the minimum wage (including elimination of the sub-minimum wage for tipped workers) or increasing worker-friendly tax credits like the Child Tax Credit and Earned Income Tax Credit .

Maybe Trump's and Harris's proposals will expire with their campaigns, just like Ron Paul's proposal did. For tax policy's sake, let's hope what happens in Vegas stays in Vegas.