Bad Tippers Are Misunderstood --- Proposal to streamline reporting of tips to the IRS shows ugly side of service economy

"Tips have always been a touchy subject. Now, they have entered the culture wars.

"Joe Biden's radical war on the working class just expanded to tipped workers," reads a recent memo from the Republican-controlled House Ways and Means Committee. A conservative outlet's news coverage last year of Toast's Restaurant Trends Report that showed residents of the Golden State being America's worst tippers said: "While California has its fair share of high rollers, not everyone is willing to share the wealth."

Kicking off the firestorm of interest in gratuities is a proposal by the Internal Revenue Service that would reduce cumbersome reporting requirements for tipped employees by using point-of-sale and electronic-payments data collected by employers. The Service Industry Tip Compliance Agreement, or SITCA, would replace an alphabet soup of programs: TRAC, TRDA and GITCA.

Why the outrage? One reason is that tips, especially in cash, often are under the table so the measure could, in theory, hit the pocketbooks of some of the lowest-paid Americans. It is a component of the "tax gap" of unreported income the IRS estimated last year to be worth half a trillion dollars. Tax advisory firm Baker Tilly notes the IRS thinks it should be receiving between 150,000 and 200,000 forms from employers reporting employees' tips while the actual number is one-third as many.

But perhaps the biggest reason taxing service workers' tips raises so many hackles is that their bosses prefer things the way they are. In many states, service workers are paid less than the federal minimum wage with the assumption that they can make it up in tips. For the many who underreport their tips, it effectively boosts that part of their income, indirectly saving their employer money at Uncle Sam's expense. Having menu prices reflect total compensation might raise prices if tips are fully taxed.

That might explain Californians' apparent stinginess. In that state, the minimum wage even for a tipped employee is $15.50 an hour. In New Hampshire, where Toast's survey says the best tippers live, the minimum is $3.26 an hour with the assumption that $3.99 an hour comes from tips. Add the two together and you get the federal minimum wage of $7.25.

Especially at restaurants where labor is a large part of the cost of a meal, restaurants would have to make up for it by charging more. Take Olive Garden, a nationwide chain owned by Darden Restaurants. A branch in Rialto, Calif., charges 10% more for Chicken Alfredo than ones in Manchester, N.H., or Huntsville, Ala. -- states with similar wage rules and generous tippers, according to the survey.

Tax evasion isn't the only issue with tipping. Especially in a higher-end eatery, it widens the gap between waiters and bartenders and those working in the kitchen who don't interact with customers and are more likely to belong to minorities. Danny Meyer's Union Square Hospitality Group said in 2015 that it would eliminate tipping, instead charging more. Five years later, reeling from the pandemic and struggling to staff back up, it reversed the policy.

Nonexistent in some countries, tipping is culturally ingrained in the U.S. and, as Mr. Meyer's experiment shows, simply raising menu prices is hard to do if everyone else doesn't follow suit. Economists call that a collective-action problem.

The same applies to those waiters, hairdressers and cabdrivers scrupulous enough to fully report their tips. If everyone else did, too, then the whole profession would ask for a raise.

In a tax system full of giveaways and loopholes, technological progress and the move away from a cash economy mean it is now possible to tax tips much more comprehensively without undue harm to workers.

It also would no longer place them personally on the hook for penalties or make them fill in dozens of forms. The ultimate cost would be borne mainly by owners of restaurants and other establishments who would have to give their employees' raises. Diners -- bad tippers included -- would have to pay a bit more, too, giving up an effective subsidy.

If that provokes too much political or industry outrage then the IRS could take the opposite tack and scrap taxes on tips completely. At a relatively modest cost in terms of forgone revenue, it would level the playing field between filers and nonfilers and eliminate tens of thousands of hours spent on paperwork." [1]

1. Bad Tippers Are Misunderstood --- Proposal to streamline reporting of tips to the IRS shows ugly side of service economy
Jakab, Spencer.  Wall Street Journal, Eastern edition; New York, N.Y. [New York, N.Y]. 23 Feb 2023: B.12.