In the race for the presidential election in the United States next November, both former President Donald Trump and his Democratic rival, Vice President Kamala Harris, are presenting their political strategies and programs to win over voters. Despite their differences on numerous issues, they have a common position on one initiative: the abolition of the tip tax.

At a rally on the campus of the University of Nevada, Las Vegas on Saturday, Harris spoke in favor of repealing the tip tax. Her comments follow a similar proposal Trump made about two months earlier at a rally in the same service city.

“I promise everyone here that when I am president, we will continue to fight for working families, including raising the minimum wage and eliminating the tax on tips for service and restaurant workers,” the Democratic presidential candidate said.

“It’s a large, large group of people that are being severely harmed,” Trump said during his speech at the Republican National Convention in July. “They’re making money – let’s let them keep their money.”

In the United States, “tipped occupations” refer to jobs in which it is common to receive tips, including waiters, bartenders, barbers, and hair stylists. Yale University’s Budget Lab estimates that about 4 million Americans were employed in tipped occupations last year, or about 2.5% of the total workforce.

The leisure and hospitality industry is the dominant industry in Las Vegas, accounting for 26% of total employment in January 2023, the State of Nevada’s Office of Workforce Innovation reported.

If this tax-free tipping rule were to come into force, it could have significant unintended consequences for the market, potentially leading to large-scale exploitation of loopholes and tax avoidance.

The advantages and disadvantages of not taxing tips

Any change in federal policy must consider both advantages and disadvantages.

This could be a big win for low-income service workers who rely on tips for their livelihoods and could reduce the tax burden on these American families. The exemption would simplify tax filing and could lead to customers tipping more generously.

However, this rule could also lead to a division of labor, favoring tipped workers over workers in similar non-tipped positions. This could lead to a shift toward tipped jobs and potentially disrupt the labor market.

Repealing the tip tax could lead to a radical change in the compensation structure. The move will likely encompass a wide range of industries, in addition to the service, retail and restaurant sectors envisioned by Trump and Harris.

For example, super-earners and corporations could reclassify their compensation as tips to avoid tax exemption. Wall Street financial executives could declare their well-paid, lucrative six-figure bonuses as “tips” to avoid taxation.

Following her speech, Harris’ campaign made clear that if elected president, she would work with Congress to develop a proposal that would include an income cap and additional safeguards to prevent high-earning professionals such as hedge fund managers and lawyers from manipulating their compensation to take advantage of the tax-free tipping provision.

Trump and Harris’ proposal could result in significant tax losses, which would likely accelerate cuts to government services. For Americans, it could also mean tax increases in other areas to offset this potential new rule.

If the law goes into effect, U.S. lawmakers will have a lot of work ahead of them as they face administrative challenges. First, the government must clearly define what constitutes a tip and who will enforce the new law.

Impact on wage negotiations and job security

Making tips tax-free could lead to a reduction in base salaries if employers adopted this compensation structure on a larger scale. Companies could use this compensation model to incentivize their employees to perform better. Employees would have to perform better to receive enough tips to offset lower compensation.

This would lead to financial insecurity because tips are not a guaranteed form of compensation. Workers’ income fluctuations would be greater because tips fluctuate.

Potentially, this rule could make some tipped jobs more attractive because they offer higher net income. This could lead to a shift in the labor market as more workers gravitate toward tipped jobs.