When President Trump proposed exempting tipped income from taxation during his 2024 presidential campaign, many viewed it as a politically expedient gimmick to win support among tipped service workers. Unfortunately, then-Vice President Harris soon followed suit, and since the election, a federal “no tax on tips” bill has been reintroduced and lawmakers in at least 20 states have proposed similar bills (see map below).

Now that lawmakers in a multitude of states have supported the idea, it’s worth unpacking just how incredibly foolish and dangerous these proposals are. In summary, exempting tips from taxes would:

1. help very few workers and undermine pay increases for many more;
2. expand the use of tipped work—a system rife with discrimination and worker abuse— potentially leading to consumers being asked to tip on virtually every purchase; and
3. deplete state and federal budgets and create new avenues of tax avoidance, especially for high earners.

No tax on tips would help few low-wage workers, while potentially undercutting pay for more

Proponents of exempting tipped income from federal and state taxes have called the proposal a “lifeline” that will “deliver financial relief” and “put cash back in the pocket of a significant number of workers.” In reality, exempting tips from taxable income will help very few workers. First, very few low-wage workers receive tips. If you look at those earning less than $25 per hour, which is just less than half of the workforce, only 5.1% are in traditionally tipped occupations.

Second, many tipped workers already don’t pay federal income tax. According to researchers at the Brookings Institute, 37% of tipped workers “earn so little that they pay no federal income tax.” Similar trends often apply with state income taxes. For instance, families in Virginia earning less than $26,500 only pay 0.3% of their income toward income taxes.

Moreover, exempting tips from taxation will lead to cases where low-income workers end up effectively losing income through losing eligibility to tax credits such as the Earned Income Tax Credit (EITC) and Child Tax Credit (CTC).1

Among tipped workers who do owe taxes, the greatest beneficiaries of this proposal would inherently be those who are already the best off—i.e., those receiving the most tips. It makes no sense for lawmakers to give preference in the tax code to servers in expensive, high-end restaurants who are receiving large tips over a waitress at Denny’s struggling to make ends meet. Nor does it make sense to give tax preference to low-wage tipped workers over nontipped low-wage workers like a bank teller, a retail cashier, or a teacher’s aide. Efforts to raise pay for low-wage workers should focus on the level of earnings, not whether payment came as a gratuity.

Ending taxation of tips would benefit employers at workers’ expense

First, not taxing tips would reduce pressure on employers to raise base wages. Employers would use the preferential tax treatment of tipped earnings as a justification to deny wage increases to their employees, allowing them to effectively capture a portion of the tax benefit.

Such measures could also undermine efforts to raise minimum wages, particularly for tipped workers. The federal minimum wage of $7.25 hasn’t been raised in over 15 years, and the subminimum wage for tipped employees—the mandatory base wage employers must pay to tipped workers regardless of their tip income—remains just $2.13 per hour at the federal level, an amount set in 1993. Even as lawmakers in 30 states and over 60 localities have set higher minimum wages, many of these states still maintain an unconscionably low subminimum wage for tipped workers.

Not taxing tips could further undercut efforts to raise compensation for rideshare, delivery, and other gig/app-based workers who receive tips, and make it more difficult to set pay standards for these workers or to challenge the legality of their independent contractor status. Moreover, if a worker were converted from a regular W-2 employee to an independent contractor under the guise of avoiding income taxes on tips, their overall tax burden could increase since their earnings could now be subject to self-employment taxes (i.e., the employee and employer sides of federal Social Security and Medicare payroll taxes.)2

These proposals will likely set off an expansion of tip requests and employers’ use of tipped work

In the wake of the pandemic, many “quick service” businesses (i.e., coffee shops, bakeries, fast food) began prompting customers to tip as part of the regular payment process, spurring some backlash. This will only accelerate if tips were untaxed and could quickly start showing up in whole new categories of consumer transactions. It’s easy to imagine businesses automatically adding “recommended gratuity” to invoices with the expectation that many consumers won’t be willing to speak up in protest. Do people really want to be asked to tip on their oil change? On their cable or broadband installation? On their dental cleaning? On their child care?

There are virtually no guardrails, other than consumers’ tolerance, to prevent tip requests from showing up everywhere. And employers will want to encourage tipping because it could allow them to pay their workers less than the minimum wage. Federal law only requires that employees “customarily and regularly receive more than $30 a month in tips” for their employers to classify them as tipped employees and pay them as little as $2.13 an hour.

Because of the perceived tax benefit, workers may give employers more latitude to encourage customer tipping and use tips to replace a portion of their base wage—a misguided trade-off. Absent much larger labor law reforms and worker protections, an expansion of tipped work would be unquestionably harmful to workers. Tip income is far more volatile than getting a regular paycheck. If a customer fails to tip or bad weather reduces customer traffic or some other factor outside of a worker’s control leads to low tip income, there’s no real recourse for those workers. Tipped workers accept this arrangement under the shaky assumption that the generous tips and well-paying shifts will offset the low-paying ones.

Tipped minimum wage laws are supposed to ensure that tipped workers receive at least the minimum wage, but this is highly problematic because tipped workers must effectively police their own employers. Not surprisingly, tipped workers experience high rates of wage theft. Customer tipping practices are often discriminatory, and tip amounts have been shown to be only “weakly related to service quality.” When tips are a significant source of workers’ earnings, they may feel forced to tolerate greater mistreatment by customers and employers out of fear of losing a tip.

No tax on tips will encourage tax avoidance and deplete state budgets

Every new tax exemption creates new strategies for tax avoidance, particularly for higher earners with the means to pay for accountants and tax attorneys. It’s easy to imagine many highly paid professionals (e.g., lawyers, consultants, accountants, financial advisors, investment bankers, etc.) opting to have their clients denote a portion—maybe even all—of their fees as “tips” in order to avoid paying taxes on them.3

Even without trying to estimate the full scope of new avoidance strategies, exempting tips from taxable income would strain already stressed state budgets. Estimates from proposals in Arizona and Virginia anticipate revenue losses of over $30 million in the first year alone. The tax benefits could accrue primarily to high-income taxpayers, yet the revenue losses would harm the public overall, as governments would have less funding for high-quality public education, safe roads, public health, and anti-poverty programs for children and families.

In some cases, such as in California’s proposed bill, tips would also be excluded from wages for the purpose of calculating unemployment insurance, meaning tipped workers would have smaller unemployment benefits if they lose their job and less revenue would be directed to the state’s unemployment insurance trust fund.

To actually help tipped workers, lawmakers should raise the minimum wage and phase out the tipped minimum wage

Ending taxation of tips is a distraction from proven methods for supporting low-wage workers, like raising the minimum wage and eliminating the subminimum wage for tipped workers. There are seven states where tipped workers already earn the full minimum wage, with tips on top. In those states, tipped workers have higher take-home pay and lower poverty rates than tipped workers elsewhere.4 And, if lawmakers want to help gig/platform workers in particular, they should support pay and benefit standards, organizing rights, and proper employee classification. A regressive tax gimmick that encourages the proliferation of tipping is not helpful to the workers who genuinely need help, and certainly not a “lifeline” to anyone. It would, however, be a boon to unscrupulous employers and tax cheats.

Notes

1. For instance, if an unmarried worker with one child earns roughly $18,000, they get the full $4,200 Earned Income Tax Credit (EITC). But if that income is two-thirds tips and $12,000 is no longer taxable, their EITC would drop by about $2000. Very low-wage workers would also lose access to the full federal Child Tax Credit.

2. Note that, at most, 12% of the workforce has done any sort of “gig” work (mostly Uber, Lyft, DoorDash, and similar) and “in the vast majority of cases, the amounts earned by workers on transportation apps have been small and supplemental to their W-2 earnings.” Only 2–3% of full-time workers are contractors whose livelihood depends primarily on self-employment income.

3. Notably, a Connecticut bill aims to limit the damage from a federal no-tax-on-tips law by requiring workers who earn more than $100,000 annually to pay state taxes on that income in the amount the taxpayer would have paid to the federal government (if the federal government eliminates the tax on tips.)

4. Those states are Alaska, California, Minnesota, Montana, Nevada, Oregon, and Washington. Michigan will soon join them. The District of Columbia, Chicago, and Flagstaff (Arizona) are also in the process of phasing out the tipped wage.