Research & Commentary: Ending the Tip Credit Would Hurt Tipped Workers

Published November 30, 2018

Increased minimum wage supporters often point to tipped workers as exploited labor while calling for dramatic wage rises. However, this is nothing more than a total misunderstanding of how tipped workers are actually compensated. Consequently, a bill introduced in New Jersey would make life far more difficult for tipped workers by increasing their base wage and eliminating tip credits.

For tipped workers, an increase in the minimum wage is unnecessary because those working under the tipped wage credit already must make at least the state-mandated minimum wage. On a larger scale, these efforts are part of an effort to increase the state the Garden State’s minimum wage to $15-per-hour, despite the fact that New Jersey’s minimum wage is already indexed to inflation.

Tip credits are the difference between the minimum wage for tipped workers in a state and the federal minimum wage. Under the federal Fair Labor Standards Act (FLSA) employees can be paid a wage of $2.13 per hour, but employers are also required to ensure their employees earn at least the federal minimum of $7.25 when their tips are included. When tip credits are eliminated the increased payroll costs which cuts into the limited profit margins (3–5 percent on average) of many restaurant owners, which forces many businesses to cut hours, employ fewer people, and/or limit employee benefits.

Eliminating the tip credit and increasing the minimum wage typically leads to a decline in employment opportunities for tipped employees. In a 2011 study, labor economists William Even of Miami University (Ohio) and David Macpherson of Trinity University used data from two datasets, the Quarterly Census on Employment and Wages (QCEW) and the Current Population Survey (CPS), to examine the consequences of reducing or eliminating the tip credit at the state level. According to a Harvard Business School study, for each $1 increase in the base wage for tipped workers, a median-rated restaurant is at a 14 percent increased risk of closing.

Using the QCEW research, which include data from 98 percent of all U.S. businesses, the authors found the following: “Each 10 percent increase in the minimum wage reduces employment by 1.2 to 2.2 percent in the limited-service sector; each 10 percent increase in the cash wage reduces employment by 0.3 to 1.4 percent in the full-service sector.”

Using the CPS data, Even and Macpherson found that a 10 percent increase in the cash wage cut the number of hours worked by tipped employees by about 5 percent. The study concludes that the loss of hours created by the elimination of the tip credit can cause a significant decline in employment opportunities for tipped employees, either through hours lost or full layoffs.

Preserving the tip credit will allow employers to hire the workers they need, providing jobs that pay well above the minimum wage when tips are included. Despite its good intentions, the proposed elimination of the tip credit along with an increased minimum wage is unlikely to decrease the number of New Jersians living in poverty. A 2007 study from economists at the University of California-Irvine and the Federal Reserve Board examined the body of work on the subject and found 85 percent of the studies they considered credible demonstrate minimum wage laws cause job losses for less-skilled employees.

Ending the tipped credit has produced poor results in other states. According to Americans for Tax Reform, in New York, more than 270 restaurants closed after the minimum wage for tipped workers was increased by 50 percent in 2015. In Maine, the elimination of tip credits was so counterproductive that the legislature restored them less than a year later.

Increasing the legal minimum wage is not an effective method of reducing poverty, and it harms workers by creating barriers to entry for less-skilled and less-educated employees. Preserving the tip credit will allow employers to hire the workers they need, providing jobs that pay well above the minimum wage when tips are included.

The follow documents examine tip credits and minimum-wage laws in greater detail.

Tip Credits and Employment in the U.S. Restaurant Industry
In this study, labor economists William Even of Miami University (Ohio) and David Macpherson at Trinity University use two government datasets to examine the effect of reducing or eliminating the in several states.

Measuring the Effects of the Tipped Minimum Wage Using W-2 data
In this research paper, Maggie Jones of the U.S. Census Bureau examines the effect of tipped minimum wages on the wages and hourly tips of servers, overall server employment. and hours worked. “The study finds that higher mandatory tipped minimum wages increase that portion of wages paid by employers, but decrease tip income by a similar percentage,” wrote Jones.

Counterproductive: The Employment and Income Effects of Raising America’s Minimum Wage to $12 and to $15 per Hour
In this Issue Brief published by the Manhattan Institute, Douglas Holtz-Eakin and Ben Gitis examine the economic and policy implications of raising the federal minimum wage to $12 per hour or to $15 per hour. “We focus on how raising the federal minimum wage would affect the very low-wage workers whom the policy is intended to help. Overall, we find significant trade-offs in raising the federal minimum wage.”

Do Workers a Disservice – Raise the Minimum Wage
In this Public Interest Institute Institute Brief, Robert N. Stewart argues minimum wage-laws actually hurt the people they are designed to help: “Most of these people are teenagers working part-time or unskilled workers seeking to advance to higher paying positions. To many of these workers, raising the minimum wage will either result in unemployment or a lower-paying position. Raising the minimum wage, altruistic as it may feel, is actually doing these workers a disservice.”

The Minimum Wage Delusion, and the Death of Common Sense
Writing for Forbes, James A. Dorn of the Cato Institute argues the commonly held belief the minimum wage helps the poor is a delusion: “The belief that increasing the minimum wage is socially beneficial is a delusion. It is short-sighted and ignores evident reality. Workers who retain their jobs are made better off, but only at the expense of unskilled, mostly young workers who either lose their jobs or can’t find a job at the legal minimum.”

Busting 5 Myths about the Minimum Wage
James Sherk of The Heritage Foundation debunks five myths about minimum wage hikes, often used by proponents of minimum-wage laws: “A higher minimum wage would help some workers, but few of them are poor. The larger effect is hurting the ability of potential workers living in poverty to get their foot in the door of employment. A minimum wage hike might help politicians win plaudits from the press, but it wouldn’t reduce poverty rates.”

Unintended Consequences of Raising the Minimum Wage
Antony Davies of the Mercatus Center examines arguments for and against minimum-wage increases and presents new results comparing employment for workers with differing educational attainments.

The Negative Effects of Minimum Wage Laws
Mark Wilson of the Cato Institute reviews the economic models used to understand minimum-wage laws and examines available empirical evidence. Wilson describes how most of the academic evidence shows minimum-wage laws have negative effects, and he discusses why some studies produced seemingly positive results.

Minimum Wages, the Earned Income Tax Credit, and Employment: Evidence from the Post-Welfare Reform Era
David Neumark and William Wascher examine the effects of minimum wages and the EITC in the post-welfare reform era.

Raising the Minimum Wage Hurts Vulnerable Workers’ Job Prospects without Reducing Poverty
Although minimum-wage laws are intended to reduce poverty, in reality, they encourage teenagers to drop out of school and reduce low-income workers’ future job prospects and earnings, observes James Sherk of The Heritage Foundation.

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