Both former President Donald Trump and Vice President Kamala Harris have put forward proposals to eliminate federal taxes on workers’ tips, appealing to a large segment of tipped employees, particularly in states like Nevada. Trump revealed his proposal on June 9, followed by Harris on August 10, with both making their announcements in Nevada—a state with one of the highest concentrations of tipped workers in the United States. The proposals aim to provide financial relief to low-income workers who rely heavily on tips as a significant portion of their income.
Complex Implementation and Potential for Abuse
Despite the good intentions behind these proposals, experts have pointed out several significant challenges. James Hines Jr., a professor of law and economics at the University of Michigan, highlights that implementing such a policy would be far from straightforward. One of the primary concerns is the potential for higher-paid workers to restructure their compensation to classify part of it as tips, thereby avoiding taxes. This could lead to widespread tax avoidance, making it difficult for the Internal Revenue Service (IRS) to enforce tax laws effectively.
Hines explains that companies could legally set up separate entities to classify year-end bonuses or other forms of compensation as tips, which could lead to a surge in reclassification efforts. Although supporters of the proposals, such as Senator Ted Cruz, argue that the IRS has a clear definition of what constitutes a tip and that reclassifying wages would amount to fraud, Hines contends that writing foolproof rules to prevent such abuses would be nearly impossible.
Lack of Detailed Plans and Legislative Hurdles
One of the key issues with the proposals from both Trump and Harris is the lack of specific details. Neither campaign has clarified whether their plans would exempt tips from income taxes, payroll taxes, or both. The payroll tax is crucial as it funds Social Security and Medicare, two programs that are vital for the financial well-being of millions of Americans.
Harris' campaign has mentioned working with Congress to develop a proposal that would include provisions to prevent wealthier individuals from exploiting the policy. However, without clear guidelines, there is a risk that the policy could be manipulated, leading to unintended consequences that could undermine the intended benefits for low-income workers.
Moreover, legislative approval is another significant hurdle. Even if either Trump or Harris were to win the presidency, the proposals would require passage through Congress, where tax policy changes often face intense scrutiny and debate. Given the complexity of the U.S. tax code and the potential for these changes to add even more layers of complexity, experts like Hines believe that Congress might be reluctant to move forward with such proposals.
Financial Implications and Limited Benefit for Low-Wage Workers
The financial implications of exempting tips from federal taxes are substantial. The Committee for a Responsible Federal Budget, a non-partisan organisation, estimates that such a policy could result in a revenue loss of between $150 billion and $250 billion from 2026 to 2035. This figure could rise even further if the policy leads to changes in behaviour, with more people attempting to declare portions of their income as tips to avoid taxes.
Supporters of the proposals argue that they are designed to help low-wage workers, many of whom rely on tips as a significant part of their income. However, experts suggest that the benefits might be limited. According to the Budget Lab at Yale, a non-partisan policy research centre, the median weekly pay for tipped workers in 2023 was $538, compared to roughly $1,000 for non-tipped workers. Additionally, a significant percentage of tipped workers—37% in 2022—already earn incomes low enough that they do not pay federal income taxes.
Given this context, Hines and other experts argue that there may be more effective ways to support low-income workers, such as expanding the Earned Income Tax Credit (EITC) or adjusting tax rates and deductions. These measures could provide more targeted relief without introducing the complexities and potential for abuse that the tip exemption proposals might bring.
While the proposals to eliminate federal taxes on tips are designed to support low-income workers, they risk adding significant complexity to the U.S. tax code and could result in unintended consequences, including substantial revenue losses and opportunities for tax avoidance
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