New Study: Tip Percentages are Higher In States with Larger Tip Credits

Cornell University professor Michael Lynn published a new study revealing a “cautionary, yellow flag” to activists trying to reduce or eliminate tip credits. Through a survey with nearly 900 responses, Lynn found consumers were more likely to tip higher (by percentage) in states with larger tip credits than they are in states with reduced or eliminated tip credits.

As a result, he claims slashing tip credits could reduce the tips restaurant servers receive, and therefore reduce or reverse the intended effect of boosting total earnings for restaurant servers.

He says policymakers should “proceed cautiously.” But just how cautious should they be?

The existing literature on the real-time impacts of reducing and eliminating tip credits sheds some light on how harmful these policies are for tipped restaurant employees: threatening employment, income, and their workplaces.

Employment   Economist Walter Wessels’ early research in the 1990s observed that restricting employers’ allowance to count tips towards the minimum wage requirement (i.e. reducing the size of the tip credit) would “inhibit the creation of hundreds of thousands of new jobs paying well above the minimum wage.” (1993). Another foundational study observed that while raising tipped minimum wage hikes may appear to have a positive effect on employment initially, continuing these increases will ultimately reverse course and reduce employment of tipped restaurant employees (1997).

Since then, economists have continued to build on this research and observed similar negative consequences for restaurant employment.

Economists William Even and David Macpherson have conducted several studies specifically targeting tipped restaurant employees. One study finds “ the bulk of the evidence” indicates raising tipped minimum wages (reducing tip credits) kills jobs and reduces hours for tipped employees in full-service restaurants (2014). More recently, Even and Macpherson found that high-wage areas such as San Francisco and Seattle had an 18% lower share of jobs and 19% lower share of hours worked in full-service restaurants compared to lower-cost states. (2019) In the most recent attempt to eliminate the tip credit at the federal level, the authors estimated doing so would eliminate jobs for nearly 1 in 3 affected tipped employees. (2020)

Most recently, economists David Neumark and Maysen Yen analyzed three decades of employment data for tipped restaurant employees. In this review, they found every 1% increase in tipped minimum wages resulted in average employment loss of 0.08% (2021). Put in perspective, that means a nearly 4% decrease in employment if the federal tipped minimum wage was increased from $2.13 to $3.13.

Income   Economists John Anderson and Orn Bodvarsson first sought to determine whether raising tip credits would actually affect tipped employees’ income. They found that largely the servers in states with higher tipped minimum wages had “no income advantage” compared to servers in states with lower mandates (2005).

More recently, Census Bureau analyst Maggie Jones found raising tipped minimum wages corresponds to a proportional decrease in tip income for employees. Her study showed a 5 to 6 percent increase in the tipped minimum wage reduced tip earnings by a similar magnitude (2016).

Even Michael Lynn’s previous work on tipped minimum wages concurs: analyzing differences in state minimum wage requirements and tipping percentages, he found states with higher tipped minimum wages have lower average tip percentages in restaurants (2020).

Businesses   Economists Dara Luca and Michael Luca analyzed the impact of minimum wage increases on San Francisco-area restaurants, which the state prohibits from taking any tip credit. They find every $1 increase in the minimum wage that affects tipped restaurant employees led to a 14% increase in the likelihood of restaurant closure (2018). In addition, they conclude increases in the minimum wage also increase the likelihood of restaurants raising their prices to adjust to the rising wage bill.

Even as tipped minimum wages have increased gradually over time, the bulk of economic literature reveals doing so has created dangerous consequences for tipped restaurant employees. So why are there so many negative after-effects from governments artificially raising the tipped minimum wage and scrapping tip credits?

The logic for restaurants is relatively straightforward: eliminating tip credits, even over a schedule, represents a massive increase in the wage bill for restaurant employers. If the current federal tip credit was eliminated, it would cause a 240% increase in the tipped minimum wage up to $7.25 per hour. Many are calling for it to go higher, up to $15 and beyond.

As the cost rises to keep tipped employees on staff, restaurants are forced to adapt. They may pass off cost increases to their customers, which presents a great risk for those whose clientele are unable to absorb large price hikes and may reduce their patronage. To mitigate this, restaurants have tried switching to a flat minimum wage model that does not allow tipping, and many have reversed course. On the other hand, they may have to reduce costs by offering fewer job opportunities or reducing hours, which takes away earning potential from employees and may also cause customer foot traffic to decline.

Servers earn a significant living through tips in states that use the traditional tip credit structure. Many say they prefer the traditional base wage-plus-tips system for its profitability. In fact, a survey of tipped restaurant employees found that 97% preferred keeping tip credits intact instead of a flat minimum wage.

Proposed ballot initiatives this year look to eliminate tip credits in Michigan and the District of Columbia. Another bill currently in the Massachusetts legislature would do the same.

Lynn’s most recent findings add to a growing body of research that points to severe consequences of these measures. Lawmakers should pay attention to the long history of damage tip credit elimination can bring.