No taxes on tips is a bad idea. And where does tipping come from anyway?

Echoing statements from both presidential candidates, one Oregon State Senator recently put forward the idea of exempting tips from Oregon income taxes. But is exempting tips from taxes a good idea?  

In this episode of Policy for the People, we explore the idea of no taxes on tips. Daniel Hauser, Deputy Director of the Oregon Center for Public Policy, explains that exempting tips from taxes would do little to improve the economic security of struggling workers, while making our tax system less fair.

We also examine the origins of the practice of tipping. Nina Mast of the Economic Policy Institute discusses how tipping is a legacy of our nation’s deeply racist past, and what that means for workers today. 

Transcript

This election season, we've heard both presidential candidates say that if elected, they'll push to stop taxing tips. Recently, one Oregon State Senator put forward the same idea at the state level. Senator Dick Anderson, who represents Lincoln City, took the initial step to introduce legislation that would exempt tips from state income taxes, stressing the need for “policies that put money back in the pockets of those who need it most.” But would exempting tips from taxes actually improve the economic security of struggling workers? 

We begin this episode of Policy for the People by examining the idea of exempting tips from taxes. Daniel Hauser, deputy director of the Oregon Center for Public Policy, explains that not taxing tips would do little to improve the economic security of struggling workers. Instead, a policy of no taxes on tips would make our tax system less fair.

The idea of not taxing tips got us wondering: Where does the practice of tipping come from? Why do restaurant servers and other service sector workers receive tips,while the vast majority of workers don't? In the second half of this show, Nina Mast of the Economic Policy Institute discusses the racist origins of tipping and what that means for workers today.

Juan Carlos Ordóñez (host): Daniel, Oregon State Senator Dick Anderson recently took the initial step to introduce legislation to exempt tips from state income taxes. In other words, to make tips no longer taxable here in Oregon. What do you make of this idea of exempting tips from taxes? 

Daniel Hauser: Exempting tips from taxes kind of makes intrinsic sense when people first think about it. You think about who gets tips. Most of the times when we're tipping people, they’re people who are making our food or bringing us food, or they're people that are making our coffees or, you know, that are providing these kinds of services. What we tend to think of as low income sectors. And I can understand why the senator thinks that's the right approach, to look at exempting tips from taxes.

And it's well intentioned, but there are some really key flaws when you get into it. First, it makes the tax system less fair. It gives preferential treatment to one type of income over other types of income. Tips would get this tax break. But someone who's just earning a low wage wouldn't. And second, it creates another opportunity for the rich and the powerful to game the tax system to their advantage. It creates openings for people to think about, how can my income be categorized as a tip and get this tax break too? And the third one is that, really, if the goal is to help the economic security of low income workers, it's not very effective. It doesn't really get the job done. And there are much better ways for us to try and help low income families in Oregon. 

Juan Carlos: Let's break down each of those points that you bring up. And let's start by focusing on the issue of fairness. Can you say more about why exempting tips from taxes would be unfair? 

Daniel: The vast majority of us work to take care of ourselves and our families. We all have bills to pay. We have mouths to feed. You know, we have to pay our rent or our mortgages. And when you take one particular type of income and you give it an advantage over other types of income, it really puts at a disadvantage workers who don't get that kind of income. So consider two people. They both make $40,000.

One is a bartender, and about $10,000 of that $40,000 in annual income comes from tips. And the other person works at a warehouse, and all of their $40,000 in income are in wages. So why does it make sense to give the bartender a tax break but leave the warehouse worker hanging out to dry? You know, there's really no policy or moral reason to treat bartenders differently than nursing assistants or retail store cashiers or any other kind of worker. There's no reason to treat Uber drivers, who might get a tip, differently from Amazon drivers, who don't. 

Juan Carlos: So you also mentioned that if tips are no longer taxable, it would create an opportunity for the rich to game the system. Why is that? After all, rich people typically don't work in jobs that earn tips.

Daniel: Yeah, well, we do know that there are countless tax lawyers and accountants whose job it is to find tax loopholes to minimize the taxes of their clients, of the rich and wealthy folks that pay them to lower their taxes. And if Oregon lawmakers were to pass a law exempting tips from taxes, you can be sure that these very folks will be trying to figure out how they can use that to their clients’ advantage.

So, for instance, you might see hedge fund managers, lawyers, well-paid professionals that are able to set up contracts and agreements with their clients, start adding in options for a tipped rate. It doesn't require you to tip them. But if you do tip them, you might get a lower required fee on that transaction, on that contract, and then that whatever that chunk is of their income that is a tip would then not be taxed.

So this could result in very large tips appearing for certain professionals, who are trying to game this to help them lower their taxes. So the potential, just creating this liability, is a risk that the state shouldn't take. This is the kind of stuff that happens when you treat one type of income differently than another. It really invites abuse by rich and powerful people who can afford to pay for the services of a tax lawyer and an account. 

Juan Carlos: I wonder if you can give us an example, a concrete example, of when this kind of abuse has happened as a result of treating one type of income differently than another? 

Daniel: Yes. There's the classic example of what's called the carried interest tax loophole. So this arises out of the fact the federal income tax system – and thankfully in Oregon we don't replicate this mistake – but in the federal income tax system, the money you make from wages, from working day in, day out at a job is taxed at a higher rate than the income people get from from selling an asset. The profits they get from selling, stocks or art or a business or something like that. As long as they held that investment for more than a year. That's called long term capital gains. 

So what's happened as a result is that certain private equity managers, hedge fund managers, have claimed that their compensation, like the fees that they should be receiving for managing those funds for their clients, are actually investment income, long term capital gains income. And so they pay a much lower rate, often on the income they get from their job, than someone who's maybe working at the same hedge fund as a receptionist. 

So really, what it's done by treating long term capital gains income at a different rate and with a preferential treatment to wages, it's created this loophole. It opened up this opportunity for some of the nation's very wealthiest people to save very large amounts of money on their taxes. And I know for years there's been conversations and efforts to address it, but somehow, these very rich and influential people have managed to continue protecting this tax break. And that's my concern, when we talk about exempting tips from taxes, is that it might seem well intentioned. A few years in, we might look back on it and be like, oh, no, this is going to rich people who are playing games with us here, and then we won't be able to fix it. 

Juan Carlos: Another point that you mention is concerning the effectiveness of the proposal, whether it ultimately accomplishes the goal of improving the economic security of workers, which is presumably the goal of the senator who introduced this idea. So why is it that exempting tips from taxes fails in that regard, in advancing economic security? 

Daniel: Yeah, it is unsuccessful at that for a number of reasons. I mean, one I'll point out is that just because you get more of your income from tips than wages doesn't mean that you make more or less of income. And why would we create this structure where we're talking about taking low income workers who get a lot of money from tips and giving them a tax break. But someone who makes maybe even less, but their money is directly in wages, like a child care worker, why are we leaving them behind? One of the things that the data nationally points out is that less than 3% of workers earn tips. The vast majority of our low wage workers don't get tips at all. So if we're really trying to think about how we help workers who are struggling, then there are much better ways of doing it. Exempting tips from taxes is not a way of broadly addressing economic insecurity for workers. 

The other reason that this really falls short is that when we're talking about low wage workers, we're talking about people who might currently not pay a lot or pay nothing in income taxes. And when we talk about then exempting their tips from taxation, it doesn't actually give them any material benefit. They don't get a larger tax return because of that. They already aren't paying it, or getting their withholding back, at least in terms of income taxes. These low wage workers are paying countless other taxes. 

And really, if we want to help those workers, there are so much better ways of doing it. The Earned Income Tax Credit is a fantastic way of helping these workers who aren't currently paying much in taxes.

But I also think if we take a step back and we think, who are the workers we would be helping with in exempting, tips on taxes? And I tend to think about a server in a restaurant who's married to someone who has a well-paying job, somebody who does marketing for a corporation or a software developer or something like that, a doctor. For this restaurant server, exempting their tips from taxes might sound nice, a nice little perk. But their family's income might be six figures. They might be making a lot of money as a family. So it's really just creates all of these weird winners and losers, when really we have much better ways of helping low wage workers be able to make ends meet.

Juan Carlos: So you mentioned the Earned Income Tax Credit being a better approach in terms of improving economic security. Can you say more about that, how that would be a better approach? 

Daniel: Definitely. So the Earned Income Tax Credit is an example of what are called refundable tax credits. So these are tax policies that even if you end up not owing any taxes you get a larger refund. And it's one of the key ways that the state and federal governments actually help address poverty. The Earned Income Tax Credit is one of these refundable tax credits. When you start earning wages, maybe making five, ten, $15,000 in wages. The EITC is gradually increasing to a point when, let's say around $30,000, $40,000 in income, depending on how many kids you have and if you're married or not – it's a little bit more complicated than this – but you could get thousands of dollars back on your federal income taxes, refundable resources back on your taxes. And the state also mirrors this federal policy. We give low income workers a percentage of their federal, kind of a boost on their federal EITCC here in Oregon. So the Earned Income Tax Credit is a really powerful way of looking at workers, people with earned income and providing them with some additional resources, some additional cash.

Juan Carlos: What are the chances that the Oregon Legislature would take steps to strengthen the Earned Income Tax Credit? 

Thank you for asking about that. That's something that I'm really passionate about: How do we strengthen the EITC? And we know in the 2025 legislative session, the session starting just here in a few months, that the legislature will have to assess whether or not to renew the Earned Income Tax Credit, because Oregon's EITC sunsets every six years. And so if the lawmakers in Oregon don't act in this upcoming legislative session, then it'll go away. This really powerful, more than $100 million every budget period, investment in low income working families will expire. And so I'm confident that the legislature will renew the Earned Income Tax Credit. But this is the exact time – we get one of these shots every six years – to really look at the EITC and figure out how it is working, how it can be made even more effective at helping families make ends meet. 

And there are really robust chances to make the ITC more inclusive. Certain folks who don't have kids but otherwise qualify for the EITC don't get it just because they're too young or they're too old. If you're outside of the ages of 25 and 65 and you don't have kids, you don't get the EITC. And that doesn't make any sense.

Plenty of people who are 67 are working and are low income workers who deserve the EITC, just as people who are 62 or people who are 27. And people who are 23 also deserve that same benefit. Why would we exclude them? So that's one example. The other is just to increase the percentage. Right now in Oregon we use a 9% rate as a starting point for the EITC. So if, let's say, you get $100 in your federal EITC, Oregon would add $9 right on top for your state income taxes. If you have a kid under three, we push that up to 12%. So if you had got $100 federally, you'd get $12 at the state level. And so we can increase those percentages. So a very simple – administratively very easy – thing we can do is change those percentages, make them higher.

We're talking to folks about increasing it to 20% for someone who has a kid, over the age of three and 25% for someone with a kid under three. So that alone would, in many cases, double someone's Earned Income Tax Credit. So for, you know, bringing us all the way back, if we're thinking about a worker who's making $30,000 a year as a warehouse worker and gets no tips, this would give them hundreds of dollars more depending on their family circumstances.

And if that same, you know, example we provided before of someone who's a bartender and gets, you know, a third or a quarter of their income in tips, they would also get this hundreds of dollars more in tax benefit, right? So we're talking about a policy that treats low income workers fairly and consistently. We're talking about making it more fair and more consistent, including folks who don't have kids and are in certain age groups, and just making it larger. It is very easy for us as a state to invest directly in these low income working families through the Earned Income Tax Credit. 

Juan Carlos: Well, Daniel, thank you so much. 

Daniel: Thank you. Juan Carlos.

Juan Carlos: That was Daniel Hauser, Deputy Director of the Oregon Center for Public Policy, explaining why exempting tips from taxes is a bad idea. 

We continue our focus on the practice of tipping. Relatively few workers get paid tips. They're concentrated in service industries like restaurants. And the workers in these industries tend to earn low wages. So where does the practice of tipping come from?

The answer is that it comes from our nation's deeply racist past, explains Nina Mast. Nina is a policy and economic analyst at the Economic Policy Institute. Earlier this year, Nina wrote a report titled tipping is a Racist relic in a modern Tool of Economic oppression in the South. Here is my conversation with Nina Mast.

Juan Carlos: So, Nina, you recently wrote a report that explains that the practice of tipping workers comes out of our nation's deeply racist past. Could you walk us through a little bit of that history and the origins of tipping workers? 

Nina Mast: Sure. So tipped worker advocates often say that tipping is a legacy of slavery. And that's because tipping in the way that we think about it today really took off after the emancipation of slavery.

So during this period, right after emancipation, Black workers were segregated into the same jobs that they were forced to work in during slavery, so many domestic work and service positions. And they were now legally owed wages. But of course, white employers wanted to avoid actually paying them wages. So instead of paying them, they suggested that the customers actually offer these service workers a small tip for their services.

And so you can see that since the very beginning of tipping in this country, it's been a way for employers to offload their wage obligations to customers. And that's really a trend that's continued throughout our history and has disproportionately impacted women and workers of color who are more likely to work in these jobs, who have historically faced the discrimination and lower wages in the service sector.

Juan Carlos: Many decades later, after emancipation and after the Reconstruction era, if we moved to the New Deal era, Congress established the nation's first minimum wage. How were tipped workers treated under that new minimum wage law? 

Nina: That's right. So the 1938 Fair Labor Standards Act is known as our landmark worker protection law. This is the law that established fundamental worker protections like the 40-hour workweek, overtime protection and the national minimum wage. But it excluded protections for workers in the service industry, so hotel workers, restaurant workers and other service workers. And these industries were deliberately excluded because they were predominantly employers of black people. And so this was a means of securing support from Southern Democrats and Congress to actually get the law passed. 

And so from the very beginning, we've seen the deliberate exclusion of service positions from a lot of our worker protection laws. And over time, that has been improved. But we still see the disparate treatment between tipped workers and other workers in our economy. 

Juan Carlos: I'm wondering whether there were particular interests lobbying to exclude service workers from minimum wage protections. 

Nina: One that sticks out, of course, is the restaurant industry. And we know that since the founding of the Restaurant Association, this is an association that has been completely focused on keeping wages low and preventing the minimum wage from being raised, or the tip the minimum wage from being eliminated. That's something that they're still doing today. But they were certainly an early advocate of excluding tipped workers from protections under the Fair Labor Standards Act. 

Juan Carlos: You mentioned the tipped minimum wage and that, as I understand it, was established in the 1960s when Congress finally put in place a minimum wage floor for tip workers. But it wasn't the same minimum wage that applied to other workers. Is that right? 

Nina: Right. So in 1966, there was an amendment to the Fair Labor Standards Act to extend some of these protections of this law to service sector workers. But this amendment actually created the tip credit system, which is the system that we still use today that governs tipped workers wages. Initially, the tip credit, which is the difference between the regular minimum wage and the wage that employers actually pay tipped workers, was set at half the minimum wage.

So in 1966, the minimum wage was $1.25. The tipped minimum wage was $0.63. Half of that. In 1996, the FLSA was amended again to raise the minimum wage from $4.25 to $5.15. But at that time, there was another deal struck in Congress that actually decoupled the minimum wage from the regular minimum wage. So it locked in the tip minimum wage at $2.13.

Juan Carlos: I'm wondering if you could give us a sense of the landscape of where we have landed today. To what extent are tipped workers protected by minimum wage laws? And listeners should understand that the federal minimum wage is the wage floor for the entire country. There are sare states that follow that minimum wage. There are states that have higher minimum wage laws. So where are we today in terms of the extent that tip workers are protected by minimum wage laws? 

Nina: There's a lot of variation across the country. Some states have really taken up the mantle of increasing their own state minimum wages, given the lack of movement on this in Congress and the fact that the regular minimum wage is stuck at $7.25.

So many states have actually increased their minimum wage above the federal floor of $7.25. But many of those states still maintain exceptionally low tipped minimum wages. For example, in Delaware, Nebraska and Rhode Island, the regular minimum wage is scheduled to reach $15 in the coming years. But the tip minimum wage is still less than $4 an hour. And so it's really an expansion of the amount of wages that are offloaded onto customers to pay. 

And then many states have established slightly higher minimum wages for its workers. And then seven states have actually eliminated the tip credit system altogether. So in these states, including Oregon, tipped workers receive the full minimum wage that other workers receive with tips on top.

But in most southern states and many Midwestern states, they still employ the maximum allowable tip credit, meaning that employers are really only expected to pay as little as $2.13 an hour, and then customers are forced to make up the rest of the worker's wage. 

Juan Carlos: So you mentioned before some of the demographic characteristics of tipped workers. We talked about how the practice of tipping is a legacy of our nation's racist past, deeply racist past. Can you say more about the demographic characteristics of tipped workers presently? 

Nina: So today, Hispanic workers, Asian American workers and foreign born as well as women workers are all overrepresented in the tipped workforce. So, you know, they're more likely to be tipped workers, as compared to other demographic groups, specifically white workers and men. And when we think about women, specifically, the tipped workforce nationwide is over two-thirds – almost 70% – women. And that's disproportionately composed of women of color. 

Juan Carlos: So how does having a sub-minimum wage, a lower minimum wage for tipped workers compared to other workers, affect their economic well-being? 

Nina: Tipped workers are paid very low wages compared to the typical worker. Nationally tipped workers are paid at least a third less than the median worker overall, and that translates to over $9 less per hour.

Being paid such low wages has some obvious effects on their living conditions. So we've seen that in states with a tipped minimum wage, tipped workers are much more likely to live in poverty. But it's also notable that in these same states, actually non-tipped workers are more likely to live in poverty as well. So the sub-minimum wage system really has a negative impact on all workers in states that do not treat their workers equally.

And then in terms of benefits, workers are much less likely to have access to paid sick leave, health care, paid vacation, all the benefits through their employer that really promote economic security and raise living standards for workers. 

And then lastly, I think what's really embedded in the tipping culture is that it sets up this harmful power dynamic between customers and the workers that are serving them. It forces tipped workers to accept abuse or inappropriate behavior because they're relying on the customer's goodwill to earn their living. So things like implicit bias or outright racial hostility. And we know that sexual harassment, especially in the restaurant industry, is rampant. One survey found that over three quarters of tipped women workers in the restaurant industry had faced sexual harassment at some point in their career, and that's the highest of any industry.

Juan Carlos: So it sounds like that even in states like Oregon that provide the same minimum wage protections to tipped workers as other workers, the practice of tipping is still problematic. It still brings certain harms to the workforce. 

Nina: I think that's right. I mean, when we're thinking about addressing poverty and increasing equity among tipped workers, eliminating the tip minimum wage is really the big focus because, while of course Oregon has already taken that huge step forward, the reality is that most states have not. But that said, I think it's true that it's definitely problematic that when tips make up the the bulk of workers wages, it opens the door for exploitation, discrimination. 

Juan Carlos: Are there any proposals, at least in Congress, to do away with the current sub-minimum wage and begin to treat tipped workers the same as all other workers?

Nina: There are. And the Raise the Wage Act has been introduced in Congress every year since 2017. Unfortunately, it still has not passed. But the most recently introduced act, the Wage Act of 2023, would phase out the sub-minimum wage for tipped workers and raise the minimum wage across the board, as well as eliminate sub-minimum wages for other workers like disabled workers, who are also subject to sub-minimum wages under our current system.

But I think given the gridlock in Congress and the fact that we still haven't been able to see the Raise the Wage Act passed, it's really important that we continue to see progress at the state level in the attempt to at least eliminate sub-minimum wages at the state level. 

Juan Carlos: Nina, any final thoughts you want to share with us regarding the tipped minimum wage and how to provide a decent standard of living for tipped workers?

Nina: I would just say it's important that we look at our current wage standards and think about the history of where they came from and look at the current harms that they're inflicting on workers. And think about how we can holistically get rid of all of these carve outs, exemptions and lower standards, because when we have these lower standards for certain classes of workers, it really encourages exploitation and inequitable treatment of workers.

And so I think it's really important that we raise the standards for some of these workers who are paid less, at least to the minimum wage, that other workers are being paid, and then also raise the standards for all these workers so that they being paid an adequate wage, receiving adequate benefits, and really just being able to, have a basic standard of economic security.