Proposals to Eliminate Taxes on Tips Are a Terrible Idea

Trump's Tax Policy Proposals Would Cost $6.5 Trillion Over Ten Years

It’s no secret that candidates for office attempt to “buy votes.” In a presidential campaign, it’s electoral math. Often, though, those promises are rooted in bad policy. This is why ethanol subsidies exist and likely aren’t going anywhere. Iowa is responsible for about a third of ethanol made in the United States, producing 4.6 billion gallons in 2023.

Recently, Donald Trump pledged to end taxes on tips. The policy is one that’s helpful among the hospitality and leisure industry, which translates to slightly more than a quarter of all employment in Nevada. Trump has also said he wants to end the taxation of Social Security benefits. Vice President Kamala Harris has echoed the “no taxes on tips” pledge, albeit based on income level.

I waited tables for more than a year. I enjoyed that job. Although we were told by the restaurant to claim 100 percent of our tips, we claimed only 10 percent of our sales to avoid any scrutiny from the IRS. This, of course, was more than 20 years ago. I have no idea if the treatment of tipped income has changed since then.

Although we’re still waiting to see what Vice President Harris plans to do on taxes, it’s a fair guess that she’ll at least keep the individual tax cuts for people earning less than $400,000 a year while also extending the expansion of the standard deduction. Those changes, enacted under the Tax Cuts and Jobs Act, are set to expire at the end of tax year 2025. She’ll likely call for an increase in the corporate income tax, probably to 25 percent to 28 percent from the current 21 percent. Her campaign is expected to release an economic plan this week. That plan should have more details on her approach to taxes.

On the other hand, Trump wants to extend the individual tax cuts under the Tax Cuts and Jobs Act, as well to eliminate taxes on tips and Social Security benefits. Apparently, he has also floated lowering the corporate tax rate, which was reduced to 21 percent under the 2017 tax law.

In FY 2023, 49 percent of federal tax receipts came by way of the individual income tax. Another 36.4 percent came via payroll taxes. Corporate income taxes were 9.4 percent of tax receipts. Other revenues—which include tariffs/customs duties, excise taxes, and estate and gift taxes—were 5.2 percent. Going back to FY 1964, individual income tax revenues are generally consistent in terms of share of revenues. Payroll taxes have become a larger revenue stream over time while corporate income taxes have become less significant.

Looking at tax receipts as a percentage of gross domestic product (GDP), generally, it’s the same story. Individual income taxes have been mostly consistent—dips in revenues commonly occurred during recessions. Payroll taxes have increasingly gone up relative to GDP, while corporate taxes have declined.

Recently, I explained that the Congressional Budget Office’s ten-year projections are problematic for congressional Republicans’ plans to extend the individual tax cuts under the Tax Cuts and Jobs Act because of the $4.6 trillion price tag over ten years. (The price tag includes debt service costs.) Extending the Tax Cuts and Jobs Act would “pay for” 1 percent to 14 percent of itself.

Considering deficits are projected to rise substantially over the next ten years, exceeding $2.8 trillion (6.9 percent of GDP) in FY 2034, a revenue cut of an average of $460 billion per fiscal year doesn’t seem smart unless there are corresponding spending reductions that come with that loss of revenue. The largest drivers of federal spending are Social Security, major healthcare programs, and net interest.

In the pie chart below, I show the breakdown of federal spending. Mandatory spending is in a shade of purple, discretionary spending is in a shade of blue, and net interest is in dark red. Social Security, major health programs, and net interest are 58 percent of federal spending. Add in other mandatory programs, we’re at 74 percent of federal spending. (Major health programs include Medicare, which is the largest program. Medicaid is the second-largest. Together, these programs are 93 percent of major healthcare program spending in FY 2023 and 91 percent in FY 2024.) Discretionary outlays, which is what Congress argues about every September and where all the rhetoric about spending is focused, is 26.1 percent of federal spending.

Now, the current policy to tax tips began in 1982 through the Tax Equity and Fiscal Responsibility Act. The little secret Republicans don’t want to admit is that President Ronald Reagan increased taxes. I admit that as a fan of his. The Tax Equity and Fiscal Responsibility Act, in fact, may be the largest single tax increase in American history. Actually, probably the better way to say it is that the Tax Equity and Fiscal Responsibility Act reporting on tipped wages rather than created the policy itself. The current statute covering the reporting of tips, 26 U.S.C. §6053, was created in 1965 through the Social Security Amendments, and it has been amended over time, including through the Tax Equity and Fiscal Responsibility Act.

The Trump campaign hasn’t been specific on how it’ll accomplish eliminating taxes on tipped wages. Legislation introduced by a group of Senate Republicans—the No Tax on Tips Act, S. 4621—proposes a deduction equal to the amount of tipped wages. The Committee for a Responsible Federal Budget estimates that the cost of eliminating taxes on tipped wage could be as much as $250 billion over ten years. Vice President Harris’s proposal could cost as much as $200 billion.

Additionally, Trump’s proposal to end the taxation of Social Security benefits has been met with even more criticism from tax policy experts. Garrett Wilson of the Tax Foundation, which has a center-right slant, writes, “Exempting Social Security benefits from income tax would increase the budget deficit by about $1.6 trillion over 10 years, accelerate the insolvency of the Social Security and Medicare trust funds, and create a new hole in the income tax without a sound policy rationale.”

Remember, the Social Security Old-Age and Survivors Trust Fund will be depleted in 2033 and the Medicare Hospital Insurance Trust Fund will be depleted in 2036. Both programs will face immediate benefit cuts unless the programs are modernized or Congress bails out the trust funds. The Committee for a Responsible Federal Budget notes that eliminating the taxation of Social Security benefits would hasten the insolvency of both programs by a year for the Old-Age and Survivors Trust Fund and six years for the Hospital Insurance Trust Fund.

So, looking at the proposals from Trump, we have a total cost of $6.5 trillion. I know some will dispute the characterization of tax cuts as a “cost,” but without offsets, it’s a hit to the deficit, the costs of which will be born in the short term through sale of securities and tax increases in the long term.

Thus far, the Trump campaign hasn’t offered any specific offsets to pay for this $6.5 trillion in lost revenue. We do know, though, that he has taken modernization of Social Security and Medicare off the table. (To his credit, Trump did float the idea in March before very quickly walking it back.) Congress could cut all nondefense discretionary spending over the next ten years and still run a deficit of $1 trillion in FY 2025 and $1.7 trillion in FY 2035.

The proposals to eliminate taxes on tips from both Trump and Harris aren’t realistic. It’s also bad tax policy. It’s a pretty obvious attempt by both campaigns try to gain an upper hand in Nevada. Trump’s proposals are even less realistic when viewed through the lens of the totality of his proposed tax policies.