Tipping private equity
President Trump‘s busyness and unpredictability resonates in two conflicting approaches to tax.
No tax on tips
On the campaign trail, President Trump told workers in Nevada – a swing state – that he would abolish tax on tips. In January 2025, speaking in Las Vegas, President Trump renewed his commitment to ‘no tax on tips’, referencing restaurant workers, bartenders, bellhops, valets and his golf caddies.
This directly affects only about 4 million workers in the US, or less than 4% of workers in the bottom half of hourly wages a small minority of workers. This group is younger than average, and 37% of them have no federal income tax liability. The IRS reported that in 2018 that $38billion in tips were taxed, with an average tipped income of $6,000. Tips may not be reported to the tax authorities, something that President Trump joked about in Nevada in January.
So ‘no tax on tips’ will probably not affect many people (but the promise may have been enough in Nevada to ensure a President Trump win).
Bad tax policy
Removing low paid tip workers from the tax net is bad tax policy: it means that tip workers and non-tip workers on the same wage pay different amounts of taxes (offending horizontal equity). Those 37% of tipped workers who do not earn enough to have a federal income tax liability would not benefit at all, but higher paid tipped workers would benefit (offending vertical equity). There are also likely to be complicated interactions with benefits and tax credits.
It will encourage employers to move to lower wages, relying on (possibly unsteady) tipping norms to reward employees.
Paying tax on tips can be administratively inconvenient. But this objection is disappearing as cash is replaced with electronic payments. Other countries (Greece, Spain, Sweden and Italy) have seen a reduction in tax evasion as payments move away from cash.
Consumer reactions
How might consumers respond to the knowledge that tips will be tax free? A 1999 study indicates that tipping is less prevalent where the national tax burden is higher. So it’s not outlandish to think that consumers could respond to ‘no tax on tips’ and become less generous. Tipping culture is mysterious: social norms are a strong reason for a discretionary payment. But norms can shift, and consumers may become exasperated with the proliferation of tipping opportunities.
I find the ubiquitous invitation to provide 20%, 22% or 25% on the (already expensive) price of a coffee really intrusive, although my uncertainty about cultural norms means that I meekly comply.
Discretionary payments
‘No tax on tips’ elevates the discretionary aspect of a payment as the deciding factor as to whether tax is due. This is perverse. Lots of payments are discretionary – bonuses, gratuitous payments, ad-hoc profit sharing. Why damage the tax base by treating tips differently to any other payment received by an employee?
Carried interest
The other tax change creating chatter is President Trump’s proposal to abolish the tax preference given to ‘carried interest’ in private investment deals. This is a long-standing tax treatment for managers of private equity and hedge funds, who are taxed at capital gains tax rates. The top rate of capital gains tax in the US is 20%, compared to a federal income tax rate of 37%.
The argument against capital treatment is that the return on the ‘carried interest’ is effectively performance pay as the managers invested little or no capital in the fund. As performance pay, the ‘carry’ should be subject to income tax.
This is a particularly sticky tax benefit: Presidents Obama and Biden tried, and failed, to abolish it. It’s not exclusive to the US: Rachel Reeves, UK Chancellor of the Exchequer, reduced the value of the tax benefit but did not abolish it. The stickiness is due to fears that private equity will move jurisdiction, high lobbying activity and, in a dastardly twist, viewed by McCaffery and Jones as a threat held over bankers’ head to drum up campaign contributions.
The contradiction
President Trump is narrowing the tax base by ‘no tax on tips’ and broadening the tax base by reforming tax on carried interest. Clearly these measures are in response to quite different political interests, and the devil will be in the detail of any legislation.
It is bizarre to take discretionary payments out of the tax net. It gives rise to boundary issues: what are tips; is there a ceiling on disregarded tips; how can employees be protected from working only for tips?
Bringing carried interest within the income tax net can be justified on equity grounds, but it hasn’t happened yet. If, this time, it really happens, might we expect private equity bankers to renegotiate their deals to work for tips?