Tipping & Wages Series: Politics Play Up the Benefits of Eliminating Taxes on Tips

Kamala Harris and Donald Trump both have proposed eliminating taxes on tips for service workers. While seemingly beneficial, it might just not add up according to renowned economics expert Larry Kotlikoff.

Named one of the world’s 25 most influential economists by The Economist Magazine, Kotlikoff has advised the Federal Reserve, the International Monetary Fund, the World Bank, and various other prestigious organizations. He is also a Professor of Economics at Boston University, with expertise spanning personal finance, inequality, taxation, Social Security, climate change, investing, healthcare, deficits, and insurance. 

The “Distinguished” podcast is produced by Boston University School of Hospitality Administration. 

Host: Arun Upneja, Dean
Producer: Mara Littman, Executive Director of Strategic Operations and Corporate Relations
Research and Content Creation: Lan Lu
Marketing: Anne Dawson
Editing: Isabella Laikin and James Leon

Music: “Airport Lounge" Kevin MacLeod (incompetech.com)
Licensed under Creative Commons: By Attribution 4.0 License
http://creativecommons.org/licenses/by/4.0

Transcript

Welcome & Guest Introduction: Larry Kotlikoff, Economics Professor at BU

SPEAKER_01 0:04

It is seldom that major party presidential candidates agree on any issue. However, in this election cycle, there is an issue on which they both agree. Both have come out in favor of eliminating all taxes on tips for service workers. While this might seem like a benefit for service and hospitality workers, it's worth exploring what kind of impact it will have. To provide clarity on this issue, we are joined today by Larry Kotlikov, a renowned economics expert, named one of the world's 25 most influential economists by the Economist magazine. Kotlikov has advised the Federal Reserve, the International Monetary Fund, the World Bank, and various other prestigious organizations. He's also a professor of economics at Boston University. I'm Arunub Neja, Dean of the Pew School of Hospitality, and I would like to extend a warm welcome to Larry on the Distinguished Podcast.

SPEAKER_00 1:02

Everyone, it's great to be with you. Thanks for having me.

Setting the Stage: Policy Over Politics

SPEAKER_01 1:05

Before we dive in, I just want to make it clear that our focus today is on money and policy, not politics. So, Larry, help us understand this proposal from both the presidential candidates to eliminate taxes on dips for service and hospitality workers.

Why Eliminating Taxes on Tips Is "First Order Stupid"

SPEAKER_00 1:24

I've got to tell you, this is one of the stupidest proposals I've ever heard advanced in a long career. So the only thing this is going to do is dramatically hurt uh hospitality workers who are receiving tips. So what we're talking about here is eliminating FICA taxes, Social Security taxes. But the way the FICA, the Social Security system works is that it's highly progressive. So these contributions that you make when you're a waiter or bus person or a cook in the back or a pot washer, uh, well, whatever it is that you're doing in hospitality, but the ones who are getting uh out there interacting with the public uh and getting tips, uh, they're not going to be making FICA contributions. So therefore they're not going to be getting uh

The FICA Problem: How Tipped Workers Lose Future Social Security Benefits

SPEAKER_00 2:30

future Social Security benefits to the extent they would otherwise be getting. And the way the system works is that for every dollar a low-wage worker contributes uh to Social Security, they get back in present value far more than a dollar because the system, the system is highly progressive, as I mentioned. So uh this is going to uh in on a lifetime basis cost uh service workers who are getting re receiving tips uh a lot of money. And uh it's also going to uh kind of spread the word to uh people who are working uh as service workers for in other occupations where tips are not a general thing, like a contractor or a uh you know a plumber, that uh not paying taxes uh on

The Ripple Effect: Encouraging the Informal Economy

SPEAKER_00 3:30

money they receive uh is okay because the waiter in the in every restaurant I go to doesn't have to pay taxes, so why should I? So it's okay if I uh ask to get paid in cash. And now all these other low-wage, basically low-earning workers will be not making FICA contributions. And uh uh again, uh they might save some money on their federal income taxes, but it won't be really enough to make up for the loss of future Social Security benefits. So I think this is really first order stupid, and uh the fact that both candidates are supporting it is testimony to how bad our uh you know their economic advisors are, uh, that they don't actually explain to them uh what really uh they're recommending. I mean, we have countries in Latin America who are uh in terrible trouble for decades, uh not just Latin America and Africa and all the emerging countries of the world, even in Russia, uh, where the underground economy, the informal sector, as they call it, is massive, and they don't can't collect enough revenue from these people to provide decent schooling and uh water supplies and public goods of all kinds, highways. And they're doing everything they can to get everybody into the formal sector. And here we have the two presidential uh candidates promoting the informal sector. It's crazy.

Unpacking the Federal Tax Picture: Standard Deductions and Who Actually Pays

SPEAKER_01 5:15

Okay, Larry, so um very provocative uh thoughts, but let's unpack this one by one. And I want to make sure that people listening understand what you mean when at the beginning when you started talking about um not paying federal taxes. So there is this concept of standard deduction, which um you know has really increased over the last few years. Um, and then there are personal exemptions. So are you suggesting that a big proportion of service workers are being covered under the federal standard deduction and personal exemptions? So they're not paying federal taxes. So at the end of the day, they are paying only the 6.2 percent FICA since Medicare everyone has to pay. So they are only saving 6.2 percent.

Employer vs. Employee FICA: Why the Distinction Is Fictitious

SPEAKER_00 6:04

Well, that's probably that. That's close to what I'm saying, but the total tax is uh 12.4 percent, which is the employer plus the employee uh shares of FICA. Now, no economist uh worth his salt uh or hersalt uh thinks that the employer paid share of the FICA tax is actually being paid by the employer. If I am working for you and Uncle Sam says uh Arun, you have to pay uh $300 uh uh a week uh for an extra taxes for Larry, you're just gonna cut my wages by $300. So because you're not uh or you'll fire me and hire somebody else, but you don't have to pay that tax on. So uh uh the point is that employer pay, it's just the employer putting the the tax payment into the mailbox and sending it. And in fact, they're putting both shares into the same uh check and sending it to Uncle Sam, and it's all being done electronically, not even with a mailbox. So this whole distinction between employer and employees is completely fictitious, and it's meant to suggest to people that the uh the size of the FICA tax is much lower than it actually is. But so the other implication here is that um when you uh uh eliminate this uh a FICA tax that the employers are paying, uh it uh it should lead uh them to uh pay their their workers uh uh potentially more money because they don't have to have this obligation. So that's the uh the plus side here. The workers' pre-tax earnings uh might end up higher uh because the employer has a smaller FICA tax obligation, if you like.

What Happens to Social Security Covered Earnings Without FICA Contributions

SPEAKER_01 7:56

Aaron Powell Well, I'm not sure that I've heard anything about eliminating the FICA contribution from the employer side. So if um an employee is earning $100 in tips and they don't have to pay the 6.2 percent, the employer still has to pay the 6.2 percent. So uh they might continue to end up paying, whereas the employee will save that 6.2 percent, which as you mentioned before is going to bite them when they start taking social security at the at the retirement time. Because um, as you've explained many times on all your podcasts and writings, um the more you are paying into, the you know, it takes top 30 years of your contribution to determine what your social security earnings are going to be.

SPEAKER_00 8:45

Well, you know, you're absolutely right that uh how exactly this goes down and the details matter, and that um you know the the benefit is ultimately connected to your covered earnings, not to your exact tax contribution. So if they so that if they you know if they just abolish the FICA tax in total and said, we're not gonna report, if you're not paying any FICA taxes, then Social Security probably won't record any covered earnings. Now, if your employer is paying their half of the of the check um or sending in their half of the total check, then maybe they'll cover Society will call your uh, let's say $15,000 of covered wages or $20,000 of covered wages $10,000 rather than $20,000, in which case your earnings record will be half as large when you hit retirement age and start trying to go collect a benefit. So exactly how this thing uh is handled in the law will matter. But the idea that they can do this without even discussing the benefit side, I mean, they're uh you know, we don't know how commerce would end up uh translating no taxation of trips into what happens to Social Security benefits.

Every Dollar Paid In Gives a Bigger Bang at Retirement

SPEAKER_01 10:13

Right. And the the other point I want to make sure that um regardless of whether Social Security counts no wages or they count half the wages, but every dollar that these employees are putting in is giving them a much bigger bang for their buck when they retire. And any loss here is gonna bite them at the retirement time. So this is another huge, big implication that you pointed

What a Thoughtful Policy Response Would Actually Look Like

SPEAKER_01 10:41

out.

SPEAKER_00 10:41

Yeah, I mean, you need to have a fully articulated that President Trump proposes this and Vice President Harris says, well, you know, uh this could really hurt, depending on how President Trump, if he's elected, uh implements this, this could really hurt uh service workers, uh uh people receiving tips. And here's how. Uh so if we want to do this, um we have to do it uh in this way, so their social security benefits are not reduced. But then we have to ask, why aren't we doing it for uh other people who are earning the same pay? Uh is this fair? We're trying to achieve equity. I mean, that would be okay, an intelligent response that would suggest that we're dealing with somebody who's actually thoughtful, who's going to run, make other decisions in the public sphere in a thoughtful manner, with the facts, with the knowledge of how things actually operate, as opposed to, well, he proposed it on for it. I mean, that's that to me is very disappointing uh on both of their parts. I mean, he's he's proposing something without even knowing, I think, what he's talking about, and she seems to be confirming it without knowing what she's talking about.

Why Single Out Service Workers? The Fairness and Legal Problem

SPEAKER_01 12:06

Right. And that was actually, this is uh the next question I wanted to ask, which is you know, there are employees, you know, people labor working in so many different industries. Why pick on this one industry and say that you're not gonna be taxed on a portion of your earnings? What kind of economic or political or some what kind of rationale there would be to pick and choose winners and losers and say we're gonna help you, but not help you, even though you both might be earning the same.

A Political Stunt: Unions, Votes, and Constitutional Questions

SPEAKER_00 12:37

You're absolutely right. It's probably uh would probably be ruled unconstitutional by the Supreme Court if it, you know, it would somebody would uh would file a lawsuit uh claiming unequal treatment, and the Supreme Court would probably overrule it. So the whole thing's a political stunt, really. Uh and maybe it's to garner the support of the service workers union uh on the part of Trump and uh to get more of uh that union's uh members uh voting for him, and then uh and then Harris has to come and be equally uh supportive of unions. Maybe that's really what's going on here, but it's um you know, in the end, uh peep it I think it would be much more um valuable to uh a potential uh waitress or waiter uh to understand that um they have a a leader who's actually thinking about all aspects of their finances, not just the immediate uh higher paycheck that they might get. But if they're if we're talking about doing something that's going to uh basically uh boomerang on them in a very bad way, uh that somebody has enough connection to the real world and connect and knowledge of how things actually work in the fiscal system to prevent some other politician from doing them damage.

Would Eliminating These Taxes Create a Significant Budget Hole?

SPEAKER_01 14:11

Okay, so I next next question I have for you is um are these taxes pretty significant that it would leave a substantial hole in the federal budget, increase our already pretty high deficit spending that we are already doing.

The Paradox: The Federal Government Might Actually Save Money

SPEAKER_00 14:29

Well uh they're not if we're just talking about how we're taxing uh service workers with respect to FICA taxes, uh then it's not going to be much uh uh it's not gonna matter much to current revenues. And really in present value, if we're talking about their benefits being dramatically reduced uh relative to their current taxes, uh the federal government might actually save money over the in present value. Okay?

Closing Thoughts and What to Watch For Next

SPEAKER_01 15:04

That's the opposite of what they're trying to do. That is so interesting. Larry, thank you so much. That was very interesting to talk to you. A lot of interesting points came up. Uh really appreciate you coming on. So there you have it. Um, it is not yet a fully thought-out proposal, and I think we should wait for all the details to come out. I know that there are some bills that have already been introduced, but those might be just instant reactions from some politicians. Um, I think we have to wait for more details to filter out from the two respective campaigns to examine this in more detail, and watch out uh this podcast for more detail. Thank you so much. Thank you, everyone.

Closing Remarks & Credits

SPEAKER_00 15:49

Great to see you again.

SPEAKER_01 15:50

Same here. Bye-bye. Special thanks to the team that produced this podcast, producer Mara Littman, editor and sound engineer Andy Halleck, and the entire team at Boston University School of Hospitality Administration. To keep up with Distinguished Podcasts, be sure to subscribe wherever you listen to your favorite podcast. You can also learn more about BU School of Hospitality by visiting bu.edu slash hospitality. Have a wonderful day.