ARE TARIFFS AND NO TAX ON TIPS GOOD POLICIES?

Trump’s proposal to eliminate taxes on tips sounds good but careful analysis shows it would benefit few workers, be unfair, create perverse incentives, and open a door for tax avoidance. On the other hand, tariffs can be used effectively, but Trump’s on-again-off-again, high, broad-based tariffs are already hurting our economy and will raise prices for consumers and businesses. They are also ripe for political corruption.

(Note: If you find a post too long to read, please just skim the bolded portions. Thanks for reading my blog!)

Let’s take a step back from the dramatic and illegal actions of the Trump administration for a moment and take a look at their policy proposals on tariffs and eliminating taxes on tip income.

Trump has proposed eliminating income tax on tips, which sounds like a good policy that would help low-income workers. However, when carefully analyzed, it’s clearly a bad idea. First, it’s one more complexity in our tax code, unfairly treating some low-income workers and one type of income differently than others. It also creates a perverse incentive to create tip income, even the conversion of regular income to tip income. This is a new avenue for tax avoidance that some employers and business people would take advantage of. [1]

Second, eliminating tax on tips would help very few workers. Workers who earn less than $25 per hour and are in traditionally tipped jobs are only 2.5% of the overall workforce, which is about 4.3 million workers. However, 37% of tipped workers earn so little that they already don’t pay federal income tax. So, fewer than 2.5 million workers would benefit from eliminating tax on tips. Moreover, some low-income tipped workers would lose their eligibility for tax credits such as the Earned Income Tax Credit and the Child Tax Credit.

It’s unfair to give this benefit to low-wage tipped workers but no similar benefit to low-wage workers who don’t get tips, such as fast-food workers, teachers’ aides, retail cashiers, and bank tellers, for example. The biggest beneficiaries of eliminating tax on tips would be servers in high-end, expensive restaurants who are already making a decent living.

Third, it undermines efforts to increase wages for all low-wage workers. Some employers might see this tax cut as a justification for not increasing workers’ wages. So, in effect, part of the benefit of this tax cut would go to employers rather than employees. It undermines efforts to raise the federal tipped worker minimum wage of only $2.13 per hour (set in 1993), as well as efforts to raise the regular federal minimum wage of $7.25 (set in 2009).

Fourth, it would incentivize increasing the number of tipped jobs because it would allow employers to pay $2.13 an hour rather than $7.25. Furthermore, tipping might proliferate to many services that currently aren’t tipped. Businesses might add an automatic “tip” to bills or classify a portion of their fees as “tips.” The use of “tipping” to dodge taxes could spread to a wide range of services such as car repair and servicing, appliance installation, child care, and even dental and legal services. [2]

An expansion of low wage tipped jobs is clearly not in workers’ economic interests and, furthermore, tipped work is rife with wage theft, worker mistreatment and abuse, and discrimination (including by tippers).

Turning to tariffs, Trump declared a fake economic emergency that gives him the power to unilaterally impose tariffs. Putting aside the disruptive aspects of threatening or implementing tariffs and then stepping back from them, let’s examine the role and impact of tariffs.

Tariffs can be used effectively to achieve important goals of economic and trade policy. They are most effective when they are narrowly targeted at well-defined goals as part of a larger, clearly established policy strategy. The three main goals of tariffs are: [3]

• Protecting domestic production of specific products for reasons of national security, resilience of key supply chains, or other clearly justified purposes,

• Protecting U.S. workers from unfair competition from specific other countries, and

• Protecting domestic climate change and environmental policies from specific other countries with weaker policies.

High, broad-based tariffs harm the U.S. economy in multiple ways, and they do not reduce the U.S. trade deficit. They raise prices of imported goods for consumers and for businesses who use inputs that are imported. Furthermore, other countries are very likely to implement retaliatory tariffs or restrictions on the importation of U.S. products. For example, when Trump imposed tariffs on China in his first term, China retaliated with tariffs on U.S. agricultural products and a ban on the purchase of Boeing airplanes. The loss of the Chinese market had such a profound impact on U.S. farmers and ranchers that the Trump administration authorized $61 billion in emergency relief for them. This ate up (no pun intended) roughly all the tariff revenue generated by the Trump tariffs. Boeing lost the 25% of its sales that had been in China, and this strengthened the Chinese competitor to Boeing and increased its sales.

High, broad-based tariffs facilitate political corruption. They typically allow importers to petition for reductions of or exclusions from the tariffs. This favors politically connected or favored companies. The first Trump administration granted more than 100,000 exclusions or reductions to tariffs through a process that the Government Accountability Office (GAO) and the Commerce Department’s Inspector General found lacked transparency and made inconsistent and apparently arbitrary decisions. Further analysis found that tariff reductions were used to reward political supporters and contributors, while punishing political opponents. [4]

[1]      Cooper, D., & Mast, N., 2/6/25, “‘No tax on tips’ will harm more workers than it helps,” Economic Policy Institute (https://www.epi.org/blog/no-tax-on-tips-will-harm-more-workers-than-it-helps-proposals-in-congress-and-now-20-states-could-encourage-harmful-employer-practices-and-lead-to-tip-requests-in-virtually-every-co/)

[2]      Cooper, D., & Mast, N., 2/6/25, see above.

[3]      Hersh, A. S., & Bivens, J., 2/10/25, “Tariffs – Everything you need to know but were afraid to ask,” Economic Policy Institute (https://www.epi.org/publication/tariffs-everything-you-need-to-know-but-were-afraid-to-ask/)

[4]      Hersh, A. S., & Bivens, J., 2/10/25, see above.