ADRIAN MA, HOST:
Donald Trump and Kamala Harris are on the same side of one issue, which is getting rid of taxes on tips. But what would that really look like in practice? And how could these policies be written in a way that is fair and doesn't just, you know, create opportunities for people to avoid taxes? My colleagues over at NPR's daily economics podcast, The Indicator, have been looking into potential guardrails for a policy that many economists believe could easily go off the track. Darian Woods and Wailin Wong take it from here.
DARIAN WOODS, BYLINE: Shannon Lee is an aesthetician, you know, skin care, beauty treatments. And she says she got into it because of her own acne. And she says when her customers come in with it, it is quite satisfying to treat.
SHANNON LEE: I think acne is, like, my favorite thing ever.
WOODS: You love acne?
LEE: I love acne (laughter).
WAILIN WONG, BYLINE: I bet Shannon and I both enjoy watching pimple popping content on social media.
WOODS: Ugh.
WONG: (Laughter) Sorry, Darian.
WOODS: No comment. Like, I'm not going to yuck your yum, as they say.
WONG: It's very compelling.
WOODS: But it's incredibly disgusting.
WONG: I can't look away.
(LAUGHTER)
WOODS: Now Shannon has her own business in New York, and we spoke there with a treatment table between us.
WONG: Shannon says the mid range for aestheticians in New York is about $22 an hour plus commissions and tips. Her employees earn about a third of their income through tips. We're talking $30 an hour or even more. Shannon gets tips too. So this proposal to make those tips tax free sounds almost too good to be true.
WOODS: If you were to not have to pay taxes on those tips, would that be a good thing for you?
LEE: Am I allowed to say yes?
WOODS: You're allowed to.
LEE: Absolutely, this would help out.
WONG: Shannon thinks other workers and business owners might be tempted to change their fee schedules so that more income comes in as tips.
LEE: I think it will change how the - people's perspective on how they structure everything.
WOODS: That is one of the big concerns from the tax experts, like Howard Gleckman from the Urban-Brookings Tax Policy Center.
HOWARD GLECKMAN: When you tax income in different ways, people are going to work very hard to characterize their income in the lower tax form.
WONG: Howard points to plenty of historical examples where a regulation or lower taxes for some types of income have meant that people changed how they get compensated.
GLECKMAN: We all now take employer-sponsored health insurance for granted. Everybody go - you have a job. You expect to get health insurance through your job. That didn't exist before World War II.
WOODS: Yeah, the Stabilization Act of 1942 froze wages and benefits. It was part of a wartime effort to control inflation. But it had a big exception. Pension plans and insurance could grow. So they did. It led to these big all-encompassing health insurance plans being a very normal part of American compensation in a job. This very American health care system is a historical accident fueled in part by people seeing loopholes and using them.
WONG: Another example that really highlights what happens when you tax two different forms of compensation differently is something big shot financial people know really well. Hedge fund managers, private equity partners, they've learned that getting paid a salary doesn't work out the best for them tax-wise.
GLECKMAN: If you're somebody, particularly somebody who's making a lot of money, and you can turn your income into capital gains, you're going to be paying a maximum rate of 20%. If it's ordinary income or wage income, you're going to be paying 37%. So there's a big incentive to change the way your income is categorized.
WOODS: Some call this the carried interest loophole. It's when in lieu of some salary, these finance people get a share of the profits from the deals the companies worked on that's then taxed at that lower capital gains rate as it's considered a profit on selling an asset.
WONG: The end result of all these loopholes and carve-outs means that the tax code can be gamed. Laws intended to benefit one group might actually benefit another, and the government finds it harder to raise revenue.
WOODS: So we posed the challenge to Howard. If the elimination of taxes on tips had to be made, how could the unintended consequences be minimized? What kind of guardrails could be put in place to reduce gaming of the system, like that hypothetical corporate lawyer with a tip jar?
LEE: So this starts getting really complicated. I mean, you certainly could put in income limits.
WONG: Capping the income at which you can get tax-free tips is something that Kamala Harris said she would do. So that would stop those wealthy white-collar workers from claiming their income as tips. Donald Trump's proposal doesn't have that detail.
GLECKMAN: You certainly could try to define those occupations that are eligible for the tax exempt tips and those that aren't.
WOODS: Again, this is something that Harris has included in her proposal - to only allow this for hospitality and service workers. Trump, again, hasn't specified this. That said, Howard is skeptical that this would solve the problem. He says that people like freelancers can redefine what industry they're in.
GLECKMAN: And they will game the system. They'll change the nature of their work just enough, so it fits a definition and allows them to get the income.
WONG: Howard says this behavior could even boil over into outright fraud. And the root of this, he says, comes down to a broader problem with the IRS.
GLECKMAN: You can put down anything. The IRS doesn't have the resources to audit you to determine what your occupation really is.
WOODS: Ultimately, though, Howard was just kind of playing along with us.
GLECKMAN: The bottom line really is, you know, it's unworkable. I mean, I'm not going to sit here and try to fix something that shouldn't happen and shouldn't actually be fixed.
WOODS: Well, I appreciate you being game at least enough to think about the hypothetical.
GLECKMAN: I try, but I'm not going to help them out on this. They're making this mess. They've got to get out of it themselves.
WONG: What Howard thinks would really support tipped workers would be an increase in the federal tipped minimum wage, which is currently at $2.13 an hour.
WOODS: Yeah, that surprises a lot of people. I mean, this varies state by state, of course, but for some states that is the minimum wage for tipped workers.
WONG: Yeah, I mean, $2.13 - that's, like, barely going to buy you a fountain drink at the restaurant you're working at, you know?
WOODS: And so just stepping back, do we think that removing taxes on tips is actually likely to happen?
WONG: You know, it's a bipartisan issue. Politicians on both sides of the aisle support it. You've got Republican Senator Ted Cruz who introduced a bill, the No Tax on Tips Act earlier this summer. Democratic Representative Steven Horsford said he's going to introduce another bill. This one's going to be called the Tipped Income Protection and Support Act. So there's a real possibility it might happen.
WOODS: This might also have something to do with Nevada being a battleground state. It's a big state for tipped workers. You've got 1 in 5 workers there working in leisure and hospitality.
WONG: Oh, wow. Yeah, so no doubt.
WOODS: It may not please the Howard Gleckmans of this world, but it's good politics.
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MA: That was Darian Woods and Wailin Wong. And listen, if you like that, maybe check out the podcast we host together, The Indicator From Planet Money. It's a bite-size show where we break down the big economic ideas in the news. You can hear new episodes Monday through Friday on your podcast thing.
(SOUNDBITE OF MUSIC) Transcript provided by NPR, Copyright NPR.
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