Behind USA’s Tip Culture: A Workaround for Employers to Escape Minimum Wage Payments

The U.S. Department of Labor (DOL) announced a series of updated regulations in 2020 and 2021 to protect tipped workers, including amendments to sections of the Fair Labor Standards Act (FLSA). These regulations protected employee tips from employers and addressed the two-tiered wage system that allowed employers to take partial credit against their minimum wage obligations based on the tips received by employees.

The FLSA established baseline labor protections that workers today possess, such as a 40-hour work week, overtime protection, and a national minimum wage. One of the most notable amendments to the FLSA was made in 1996, extending protection to service workers, who were previously excluded from FLSA. This amendment introduced a unique permanent subminimum wage for workers who received tips, under the assumption that worker’s tips combined with the sub-wage would ensure hourly earnings equal to the regular minimum wage. Tip credits allow employers to claim a portion of an employee’s tips against the employer’s obligation to pay minimum wage. This regulation fundamentally changed the practice of tipping from an expression of gratitude to the server to a subsidy from consumers to the employers of tipped workers. Now, customers shoulder the burden of tipped workers’ wages via tips.

The federal regular minimum wage in the U.S. is $7.25. However, employers are required to pay their tipped staff a “tipped minimum wage” of only $2.13 per hour. Consumers bear responsibility for paying workers the remaining $5.12 per hour, about 71% of the minimum wage requirement. In 1996, the tipped minimum wage was decoupled from the regular minimum wage. Consequently, the regular minimum wage has increased while the tipped minimum wage has remained at $2.13 since 1991. Moreover, its proportion has decreased from 50% of the regular minimum wage in 1991 to 29% of the regular minimum wage in 2023. Additionally, inflation has decreased the purchasing power of the federal tipped minimum wage to its lowest point ever.

While all but eight states have provisions for minimum wages, employers can legally choose to pay their tipped workers a subminimum wage, which is as low as $2.13 in 27 states. Economists estimate that at least 5.5 million workers are paid on this basis.

Source: Economic Policy Institute

This complex two-tier wage system puts the burden on workers to monitor and advocate for fair pay. Yet, there is evidence of abuse of the tip credits system at workers’ expense. The last robust compliance investigation of full-service restaurants by the Labor Department (2012) found that 83.8% of the examined firms were in violation of labor law, with a large share of the infractions related to tips. 1,200 violations were found, amounting to a total loss of $5.5 million in wages to tipped workers.

In 1988, a rule was introduced requiring employers to pay employees the full minimum wage whenever they spent more than 20% of their weekly hours performing non-tipped work such as cleaning or preparing food. While this rule was withdrawn under the Trump administration, the Final Rule, effective as of December 28, 2021, requires employers to pay tipped employees the full minimum wage when non-tip-producing work is performed for a substantial amount of time. This would require employers to revisit their current policies regarding compensation of tipped employees and record keeping: tracking time spent in tipped and non-tipped services.

The Final Rule defines three distinct categories of work: tip-producing work, work that directly supports tip-producing work, and work that is not part of the tipped occupation. The Rule also defines “substantial time” as either more than 20% of the hours in the workweek for which the employer took a tip credit, or a consecutive period exceeding 30 minutes. Finally, Civil Money Penalties (CMPs) are imposed on employers who violate the FLSA by taking tips earned by their employees, regardless of whether those violations are repeated or willful. The Wage and Hour Division of the DOL may assess such penalties for violations of the minimum wage and overtime requirements of the FLSA, with fines of up to $1,100 for each violation.

While this new rule protects tipped workers’ wages, it is too late. The federal minimum wage floor has been stuck at $7.25 since 1991 and falls short when compared to the global employment landscape.

The U.S. is limited by its approach to federal minimum wage policy. Since it is set out in statute, it can only be changed if Congress passes a bill to do so and the president signs it. Such a system where wage policy rests directly in the hands of lawmakers is in contrast to most other countries. Out of 197, only 17 countries (about 10% of those with minimum-wage systems) set their rates by statute, which can make them more difficult to update. Additionally, the U.S. has no legal requirement to periodically review and adjust its minimum wage, hence the 32-year stagnation of the federal wage floor. On the other hand, close to 80 countries set minimum wages by national law and include explicit mandates to revisit them annually or once every two years.

Tipped workers typically fall in the bottom quartile of all US wage earners, even after accounting for tips. Employment in the full-service restaurant industry has grown over 85% since 1990, while overall private-sector employment grew by only 24%. However, tipped employment continues to be overwhelmingly low-wage work. Wage theft is particularly acute in food and drink service due in part to employers exploiting tip credits and tip pooling allowances.

Research also indicates that a subminimum wage floor for tipped workers perpetuates racial and gender inequities, resulting in worse economic outcomes for tipped workers. High reliance on tips for service workers creates instability in income flows and subjects them to a higher risk of income loss from sudden events such as the pandemic. Additionally, evidence indicates that tipping has been a discriminatory practice, with black service workers receiving smaller tips than their white counterparts for the same quality of service.

The impact of the wage floor separation for tipped workers is best evidenced in the differences in poverty rates for tipped workers.

There is evidence of higher median incomes for tipped workers in states where there is equal treatment for tipped and non-tipped workers. Evidence also shows higher growth in the number of businesses and establishments, such as restaurants, in states with equal treatment and higher employment growth when compared to states that implement the federal floor of $2.13.

While amendments to the FLSA that ensure protection of tipped workers’ wages and provide safeguards against wage theft are important steps, there is a glaring need to revisit and raise both wage floors. The present system does not internalize these low wages and hence worsens the living standards that tipped workers are subject to. There is an opportunity to improve economic welfare, living conditions, and poverty rates in the country by simply eliminating the two-tier system and giving tipped workers basic protections afforded to other workers.

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“29 CFR Part 531 Subpart D — Tipped Employees.” https://www.ecfr.gov/current/title-29/subtitle-B/chapter-V/subchapter-A/part-531/subpart-D