Earlier this week, Vice President Kamala Harris, campaigning in Nevada, endorsed exempting tips from the individual income tax. This follows former President Donald Trump’s proposal last month to do the same. This policy has obvious political appeal to bartenders, waitstaff, hairdressers, Uber drivers, and others, but it is not good tax policy.

Under current law, tips are considered ordinary income and subject to both the individual income and payroll tax. Tips are already somewhat tax preferred because employers receive a credit for any employer-side payroll tax remitted on tips, and cash tips are likely underreported. According to IRS data, approximately $38 billion in tips were reported in 2018.

Exempting tips from the income tax would violate three important principles of tax policy: equity, efficiency, and simplicity.

A tip exemption would be unfair. Exempting tip income would mean that two individuals (for example, a restaurant waiter and a house painter) with identical pre-tax income could face quite different tax burdens.

This would not always work out in obvious ways. Depending on its design, a tip exemption could make some low-income households with tipped workers worse off than non-tipped workers. If tips are excluded from gross income, low-income tipped workers with children will report less earned income and will therefore receive less Earned Income Tax Credit (EITC) and child tax credit. For example, a tipped worker with one child that earns $24,000, half of which are from tips, could lose out on roughly $300 in refundable tax credits if this policy was enacted into law.

A tip exemption would be inefficient. By exempting a form of compensation, it will distort both where people work and the types of jobs they will take. By increasing the returns to tipped work, it will attract workers to the service industry and away from industries and jobs where they could be more productive. In addition, tipping may become common in more industries as workers increase their preference for this less predictable but tax-exempt form of income.

A tip exemption could be complex. For example, the Harris campaign indicated that their plan would carve out workers in certain industries and high-income households from the exemption. Any phase-out of the exemption for higher income earners will place an additional compliance burden on affected taxpayers. Such a phase-out would also discourage work by raising these taxpayers’ marginal tax rate.

In addition to these broad faults of principle, exempting tip income would be costly. While tipped workers are roughly just 2.5 percent of all workers and many of those workers already do not pay income tax due to their low income, exempting tips from the income tax would still reduce federal revenues by at least $100 billion over the decade. Revenue loss would be more than twice that amount if tips were also exempted from the payroll tax.

Given that most states with an income tax rely on the federal income tax definition of adjusted gross income, exempting tip income at the federal level could reduce tax collections at the state level as well. Of course, states could override this by choosing not to conform to the federal tip exemption but doing so would create additional burden and complexity on tipped workers.

Both presidential candidates should abandon this proposal.

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