States, Congress Need to Hop Off the ‘No Tax on Tips’ Bandwagon

Political popularity isn’t always a reliable gauge of sound policy—and that’s certainly true of President Donald Trump’s idea to eliminate taxes on tips, bonuses, and overtime pay.

Members of Congress are debating these campaign promises as they work on tax legislation. But across the country, we’re also seeing state policymakers embrace this idea. In 12 states—ranging from Alabama to New Jersey—lawmakers have introduced bills that, in one way or another, embrace the “no tax on tips” agenda.

Politically speaking, it makes sense why these proposals have taken off. Polls have shown that 73% of Americans across party lines support eliminating taxes on tips. But what’s popular isn’t always what’s sound.

These sorts of tax exemptions introduce severe inequity in the tax code. Two workers earning the same salary could face entirely different tax burdens simply because of the nature of their respective jobs.

A bank teller earning $30,000 per year in a state with a 5% flat income tax rate would pay nearly 65% more in income taxes, compared with a waiter down the street who also makes $30,000 a year between his income and tips.

This plays out across many lines of work. A janitor at a hotel who earns overtime would pay less in taxes than a third-shift factory union worker who brings in the same income in a 40-hour workweek.

These tax exemptions, by the very nature of their design, pick winners and losers in the tax code. Crucially, while some low-income earners are in tipped professions, the vast majority aren’t. The benefit is poorly targeted.

But the no-tax-on-tips framework doesn’t just introduce inequity. It also creates a perverse incentive structure for employers, workers, and policymakers alike.

For employers, the pressure is now off to raise base wages to retain talent, instead shifting some of the compensation to tax policy rather than payroll. Some may even decide to restructure their entire operations as overtime becomes cheaper than hiring additional employees.

For patrons already irked by an expanding tip culture, an incentive structure that pushes far more compensation toward tipped income may be particularly unwelcome and cause reluctance to tip generously, even for traditionally tipped professions. Some customers may wonder why their server’s income is untaxed, but the dollars they earned to provide that tip enjoy no such benefit.

While these proposals aren’t intended for the wealthy, the potential for abuse is high.

What’s to stop certain professionals from restructuring their compensation and contracts around bonuses or even tips? And might salaried employees who already work long hours find it beneficial to shift to an hourly pay with an overtime model that approximates their current salary but exempts much of it from income taxation?

These concerns don’t even address the macroeconomic impact of these proposals. Federal exemptions on tips ($118 billion over 10 years) and overtime ($680 billion over 10 years) come with hefty price tags.

In states where this experiment has been tried, the price tag has far exceeded lawmakers’ expectations. Alabama, for instance, exempted overtime pay from taxes from 2023 to July 2025. What was supposed to cost $34 million has already gone $310 million over budget. In Montana, where the tip exemption was recently reversed, budget shortfalls led to less money for things like schools and roads.

The US government shouldn’t create these carveouts in the tax code, and states would be wise to abandon these proposals too. But that doesn’t mean that tax relief for low- and middle-income workers shouldn’t be a priority.

A smarter form of relief would be for states to look at their standard deductions and see how they fare against the federal allowance. A larger standard deduction provides broad-based relief without picking some workers in specific industries as tax winners. Reforming overtime laws to raise eligibility thresholds—currently just $35,568 annually—also would ensure more workers receive time-and-a-half pay without relying on tax breaks.

No tax on tips sounds like a win, but it’s a short-sighted fix that would lead to long-term drawbacks. Lawmakers would be wise to look toward tax reforms that lift all workers, not just a few.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Abir Mandal is a senior policy analyst at the Tax Foundation.

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