Dudley and Tip Credits

Jacob Grier e-mailed me a while back to get my reaction to a little kerfuffle that has arisen around Chris Dudley's suggestion that Oregon should perhaps give a tip credit to employers of workers who routinely get tips.  The idea is that tips are a part of the compensation and so the minimum wage, which is designed specifically to ensure a decent minimum level of income for the lowest paid workers, can be reduced slightly to adjust for this fact.

Kari at BlueOregon thinks that this is a bad idea and Jacob thinks that this is not such a bad idea.

Perhaps in a surprise to no one, this economist is on Dudley's side here (and I have worked for tips before, just so you know).  I think I tipped my hand in the first paragraph (get it? tipped my hand...).  

Okay, bad puns aside, the point is that tips are just as much a part of compensation as are wages, working conditions, free food, etc.   It doesn't matter that wages are paid by the employer and tips directly by the customer.  It is only by being a server that a worker earns a tip so it is all part of the job's compensations.  If we are serious about setting a minimum wage floor (and Oregon is, as we have one of the highest in the country) that is meaningful in terms of giving a living wage, then why must we insist that tipped employees get more?  Are they a special class? And by the way it isn't just food servers, but bartenders, hotel workers, etc. (but I will stick to using the restaurant example as it is the most common).

I suspect that in this economy there is a surplus of would-be servers out there that would gladly take a job that guaranteed a combined compensation of the minimum wage.  By creating this distortion through a high wage floor, you increase the cost of running a restaurant, which of course shows up in the price of food.  The simple law of demand suggests that by increasing the price of food you lower the quantity of restaurant meals demanded which means fewer jobs for waitstaff.  If Oregon's minimum wage were very low, then perhaps I would feel differently, but I am pretty confident that Oregon's generous minimum wage is a very reasonable floor and I see no need to raise it for one type of worker.  Jacob makes the point that compensation will just be adjusted elsewhere, perhaps by not offering good health care benefits.  An economist would say (and I am one, so I do say) that rather than mandating one type of compensation, let the employer and employee negotiate whatever they want. Maybe someone has coverage on a partners plan, so give them more wage, maybe someone else wants coverage and would like the lower price that can be had by groups, so give them lower wage and more health insurance. By restricting these negotiations you are reducing welfare.

I should note here that the economics of the minimum wage are not as cut and dried as most Econ 101 texts show (and that I allude to above).  Yes, a wage floor can create a surplus of job seekers that can increase unemployment, but it might also be true that minimum wages increase job tenures which is generally more efficient, and it may make workers more productive (we call this 'efficiency wages').  There is also the perverse incentive that high minimum wages, which disproportionately affect the young, can encourage youngsters to work rather than go to school.  But we are getting too far afield.  Suffice to say that the empirical evidence is mixed.

To me this is in the same class of distortions as is the prohibition on self-service gas.  Yes the benefits are clear in the employees pumping the gas, but the costs are not so clear, yet no less real.  By creating these distortions you ultimately lower social welfare.  The tip credit issue is not a huge one in terms of the impact on the economy, so I neither actively support adding a tip credit nor do I condemn the idea.  But the economics are pretty clear - distortions matter.

As an aside, it would be interesting to know how consumers' tipping behavior changes in the presence of, or absence of, a tip credit.  I suspect that it differs little now, but if they were made aware of the difference, how would they react?  Hmmm....