"No Tax on Tips" Is Good, Actually
Yes, it's pandering. But tipped wages distort the labor market in ways that disadvantage workers. Tax policy ought to reflect reality.
Bill Kristol sat in for Sarah on the Secret show today and we talked about how shrewd the Harris campaign has been to date: It really is impressive that they’re building this plane while flying it.
Also, we did some pointy-head poli-sci discussion of how the compressed timeline of the race might be the single most important fundamental and that this factor favors the “change” candidate—which is Kamala Harris.
It’s a pretty sunny episode, tbh. You can catch it here.
1. Pandering
Josh Barro has been advocating for Kamala Harris to pander to voters. His basic argument is: Voters overwhelmingly like a bunch of dumb populist ideas and Harris is trying to win an election, so she should give The People what they want.1
Harris has obliged, rolling out some populist-y economic proposals. Some of these will be bad ideas.2 Some will be good. Others will be mixed. But I want to defend one of them in particular: Harris is correct to steal Trump’s “No Tax on Tips” plan.3
Abolishing the federal tax on tips is pandering, specifically to service-industry workers in Nevada. But it’s also good idea on the merits, because it restores a basic economic reality that has been warped by technology over the last 20 years.
This is going to get pretty wonky. But I hope you’ll stay with me.
Tax policy treats tips and wages as the same thing. They aren’t. A wage is a guaranteed, agreed-upon stream of income. The wage flows directly from the employer to the worker. In that way, it can be seen as a contract which creates two important economic dynamics:
The employer becomes part of the broader labor market, and has to respond to supply and demand (of labor) by raising or lowering the wages it pays.
The worker can negotiate her wages directly with the party who pays her.
The effect of these two dynamics is to create a relatively transparent and fair market for labor, in which the worker and employer each have clearly-defined incentives.
Unlike wages, tips are non-guaranteed and subject to wild fluctuation. But more importantly, tipped wages create a gigantic distortion in the labor market which disadvantages the worker.
Pretend I’m a waiter at Big Sally’s Diner and you come in to eat.
Who is my employer? Is it Big Sally, who pays me a nominal wage4 in order to maker her business function? Or is it you, the customer, whose tip will make up the lion’s share of my income for that hour?
Tipping distorts the labor market by severing the connection between the de jure employer (Big Sally) and the worker (me) and in its place creating a phantom relationship in which you (the customer) also become my de facto employer.
This distortion creates a bunch of downstream effects, one of which is that tipped workers get left behind by the workings of the normal labor market—because their “real” employers don’t actually pay them and the “customers” who pay their wages are insulated from market forces.
Combine that distortion with the transitory and voluntary nature of tipped wages and there is absolutely no reason the tax system should treat income from tips and normal wages as interchangeable.
So why does the tax system treat them the same?
Because for a long time the tax system didn’t actually treat tips and wages the same. It merely pretended to. For decades—generations—tips weren’t subjected to taxation in the real world. Tips were paid in cash and the universal reality was that service industry workers didn’t report them.
This reality is precisely why the economics of the service industry evolved as they did: Service industry employers were able to outsource payment of workers to their customers precisely because doing so meant that the tipped-wages would not be taxed.
Over the last 20 years America has become an increasingly cash-less society. Tips, in particular, migrated from cash to credit cards—and tips that come through credit cards do get reported and hence are subject to federal income taxes.
People who had ordered their economic lives around tipped income that was not subject to taxes were hit with a giant new tax.
Yet the service industries themselves did not face any adjustment—again, because of the distortion tipping creates in the labor market. In a normal labor market, if workers were hit with a new tax, they would respond by seeking jobs with higher wages and over time employers would have to respond.5
But when tipped workers are hit with a new tax reality, their “real” employers are immune. Your waiter could negotiate with Big Sally about getting a higher base wage from the restaurant—but those wages are already being taxed. Your wait can’t negotiate with you, the person sitting at the table eating the food he’s served you. And you ultimately pay your waiter a lot more than Big Sally does.
All of which explains how the shift away from cash created a large, de facto tax increase on tipped workers without introducing any counter-pressures on service-industry employers. The broader service sector has continued unchanged even as tipped workers took a haircut.
The conservative argument against “No Tax on Tips” is that there’s no reason a waiter’s income should get a special carve-out from taxation when a grocery clerk’s income does not.
But this strictly legal view ignores the legacy systems and longstanding reality: For generations the waiter’s income did not face the same taxation as the grocery clerk’s and the economic systems in their respective industries developed according to that reality, irrespective of what tax law said.
Properly understood, civil law should conform to reality, not attempt to warp reality in order to satisfy arbitrary conceits.
A brief aside before we get even wonkier:
We’ve picked up a lot of new readers over the last few months and if you’re one of them, you’ll notice that there aren’t any ads on this site. You’ll also notice that very few of our products are paywalled. And that we try to have substantive conversations here, every day.
We can only operate this way because of Bulwark+ members. So thank you, fam, for all of your support. And if you want a project like The Bulwark to exist in the world and you can afford to do so, I hope you’ll consider joining us.
As always: If you want to join Bulwark+ but can’t swing it, just drop me an email and we’ll figure something out. (That’s another thing we can do because of your support—and it means the world to me. Thanks.)
2. The Purpose of Laws
Consider the landmark 1984 Supreme Court decision Sony v. Universal.
That case revolved around the invention of the VCR recorder. Until 1984, it was technically illegal for someone with a VCR to record a TV show—it was an infringement of the copyright.
But the courts understood that in a world with personal video recording devices, the old understandings of IP law could not hold up. Faced with the prospect of turning everyone in America into a criminal or adjusting the law to fit new technological realities, the Supreme Court wisely chose that latter.
This is the precept behind eliminating the taxation of tips.
While the taxation of tips is a longstanding feature of notional tax law, it didn’t exist in the real world until recently. It has been brought into being by an unassociated technological change and this change has only resulted in an extra tax burden being placed on workers without creating any corresponding changes in the service industry which might keep the workers wages at an equilibrium.
Tax law should be brought into conformity with the longstanding reality of this peculiar industry and should formally recognize that the labor market for tipped wages functions differently from the broader labor market because of a century’s worth of legacy decisions and traditions.
So yes, eliminating the tax on tips is pandering. But it’s also a good—and fair—policy.
3. The Amish and AI
From the New Atlantis:
“The moon blew up without warning and for no apparent reason.” We were doomed. All we could do was crash resources into space programs and get a few thousand of our best and brightest into orbit before a hard rain of meteors destroyed all life on the surface of the Earth.
The astronauts and engineers of the International Space Station were able to handle the logistics of keeping people alive in their hastily designed capsules, but not the politics of keeping them happy. A social media mob denounced what little leadership there was and fomented a rebellion.
Between mutinies, asteroids, and desperation-borne cannibalism, the population was reduced to just a few women. All was not lost: they had a fully stocked genetics lab and the expertise to use it for asexual reproduction. Now, five thousand years later, humanity thrives in a world at once technologically astounding and sociologically plausible.
Some readers may recognize this as the plot of Neal Stephenson’s 2015 novel Seveneves. The book was justly praised at the time, and it has one element that deserves particular attention today: the idea of “Amistics.” Coined by Stephenson and named after the Amish, Amistics is the term the people of the repopulated Earth use to describe “the choices that different cultures made as to which technologies they would, and would not, make part of their lives.”
For the real Amish, Amistics requires deciding which technologies will fit the Ordnung, or rule of life, and which would undermine it. Every option from roller skates to internal combustion engines to compressed air to power tools is weighed and assessed rather than accepted by default, and to some extent, different communities will interpret the rules differently. But the Amish are unique, in Stephenson’s telling, not so much in the particular decisions they make as the fact that they know they are deciding at all: “All cultures did this, frequently without being consciously aware that they had made collective choices.” The enlightened spacefaring humans of the distant future know that “each enhancement is an amputation,” a surrender of one potentiality in the pursuit of another. They want the choice to be theirs.
In America today, we are bad at conscious decisionmaking about technology.
Here’s Barro on The People and democracy:
Harris is trying to win a presidential election, and to win elections, you run on popular ideas. And the voters, in their infinite wisdom, strongly favor laws against “price gouging.” If you really feel like giving yourself a headache, I suggest reading this slide from Evan Ross Smith, pollster for center-left Democratic policy initiative Blueprint, showing voters’ opinions on various proposals to fight inflation. You will see that the two most popular ideas for disinflation — lower interest rates and lower taxes — are in fact inflationary. The third most popular idea, and the most popular idea that wouldn’t actually tend to push prices up, is to “prosecute companies for price-gouging and price-fixing,” as Harris will announce a plan to do tomorrow.
I spend a lot of time lecturing the left about the need to make compromises instead of demanding that campaigns be run on their loser policy ideas. Well, that lecture applies to me, too: The public demands action against “price gouging,” my objections to such laws are a political loser, and I should make peace with the fact that I won’t get my way on this issue. That is how democracy works.
As Noah Smith explains, the Harris proposal for price controls on food is a bad idea, full stop.
In fairness to Harris, her version of No Tax on Tips is smarter and better thought out than Trump’s, so it’s more accurate to say that she’s improved on Trump’s plan.
Which is, by law, exempted from federal minimum wage standards. Another market distortion.
With the eventual costs of these higher wages being passed on to consumers, obviously.
Guys: This is my favorite comments section discussion in a while. Keep it going. Very proud of you all.
Tips You really need to identify tips and who is eligible - otherwise a HUGE LOOPHOLE. I can tip my lawyer, accountant, plumber, stock broker.