Dumb tax policies Trump Edition

From WaPo story about Trump’s Las Vegas campaign rally:

Campaigning in a state powered by the service industry, Donald Trump said Sunday that his administration would eliminate taxes on tipped income as a “first thing” if he is reelected.

“For those hotel workers and people that get tips, you’re going to be very happy. Because when I get to office, we are going to not charge taxes on tips,” Trump said during a rally in Las Vegas.

This is a classic case of smart, but crass, politics potentially driving dumb tax policy.

Dumb tax policy

It’s dumb tax policy for a host of reasons. Among others, an exemption for tip income:

• Violates basic equity by favoring people who receive tips over those with the same income from only wages.
• Violates efficiency or neutrality for the same reason and encourages recasting wage income as tips.
• Increases complexity by creating a host of definitional and legal issues necessary to distinguish tips from other income.
• Creates compliance challenges. Employers and employees will have strong incentives to recast income as tips. One can expect reported tips to grow dramatically and wages to decline correspondingly. One can imagine Silicon Valley tech bros designing gig apps to wring the maximum tax benefits out of any rules that are constructed. (To be fair, taxing tips already creates many enforcement and compliance challenges but in the service of equal treatment and sensible policy. Cash tips are woefully underreported for that matter.)
• Undercuts social security’s finances and the SS benefits of workers who have the thinnest of other sources of retirement income. That assumes the exemption extends to FICA, which is likely the biggest tax paid by many tipped employees.
• Provides one more (legitimate) reason for people to conclude that the tax system is riddled with special rules for the politically favored. At some point, there will be too many straws on that camel’s back.
• Etc., etc.  

Would an exemption affect tipping behavior – e.g., by causing some to reduce their tips, justified on the basis that their service providers get a tax break? Probably. This is just one example of unintended consequences and how targeted tax breaks benefit other than their intended recipients.

Smart politics

As is so often the case, Trump has good political instincts:

• Nevada, dominated by the tourism and hospitality industries, is a critical swing state with many tipped employees. Biden narrowly won it in 2020. Trump is comfortably leading in the Nevada polls and wants to solidify that position.
• An exemption for tips appears pro-little guy/gal and is progressive by favoring lower-income workers. This counters a typical shibboleth that Republicans generally and Trump specifically favor plutocratic-favorable tax policies. Trump is a plutocrat, after all, despite his campaign rhetoric, and always looks out for himself.
• The public reflexively likes tax cuts and is favorably disposed to tipped workers (waiters, barbers, Uber drivers, etc.).
• The public does not generally think about tax cuts as a zero-sum game. For example, cutting XYZ’s taxes does not imply I will be paying more. That is likely the case because deficit financed tax cuts are now the norm. The public has been lulled into thinking nobody really “pays” for tax cuts or so it seems to me. The political downside of advocating targeted cuts is minimal as a result. The common person’s mind does include a natural budget constraint, unlike the real world.
• The bad features and effects of an exemption (see above) require a little thought about economic effects and are not obvious to Joe and Jane Public.

Will it matter?

There are two dimensions to this question. Will it help Trump win? Will it affect policy if he does?

On the former, I have no special insight but would not be surprised if it does. All accounts (polls and pundits) suggest the election will be exceedingly close. Anything that moves the vote in a swing state, like Nevada, helps. A large portion of tipped workers are minorities, especially in Nevada, groups the Trump campaign needs help with.

Second, Trump is leading in the polls narrowly and is the betting favorite (6/11/2024). So, there is a good chance he will be the president once again. If required to bet on the presidential election now, I would bet on Trump (distasteful as that is) based on the best available evidence and that any of a multitude of adverse external events could further tilt things in his favor. When stuff goes wrong, voters tend to hold incumbents, especially presidents, responsible even if it totally or largely outside their control. The example of shark attacks hurting Woodrow Wilson’s 1916 vote totals is the classic example (or maybe not but other less extreme examples certainly do).

As to whether it will affect actual tax policy decisions, one can easily dismiss it as just another toss-off campaign promises likely to be forgotten after the election or ignored by the more sober tax writers in Congress. I wouldn’t be so sure. In fact, if required to bet, I expect something to be enacted if Trump wins and the GOP controls Congress as will likely be the case if he wins.

Coming up with some sort of half-baked accommodation seems likely – e.g., an off-the-wall example would be to add tips to QBI in a TCJA extension. That would further entrench that obnoxious provision that key MAGA members (e.g., Steve Daines and Ron Johnson) love so much. A more benign option would be a small above-the-line deduction, similar to that for teachers’ classroom expenses.

We wonder why tax policy is such a mess. SIGH

Addendum update

A day after I posted this, Trump floated (per a Rep. Tom Massie tweet) in his private meeting with members of Congress an even dumber tax policy idea: replacing the income tax with tariffs. I guess you don’t need a tip exemption, then.