Should Tipping Be Abolished?

Policy Reports | Work & Wages

No. 382
Monday, March 28, 2016
by Richard McKenzie

The practice of tipping restaurant servers and bartenders is under attack. Some academics and pundits want to abolish tipping and replace the practice with a higher minimum hourly wage or a so-called “living wage,” generally described as the wage rate required to lift the living standards of a household or family with only one worker above the poverty line.

Executive Summary

Yet tipping opponents do not seem to appreciate the economics of tipping. Servers at many moderately priced or casual restaurants with table service earn far more than the abolitionists realize. Tipping has economic advantages for everyone concerned: restaurant owners, their customers, servers and other workers.

Tipping abolitionist Saru Jayaraman has argued in the New York Times that tipped restaurant servers have historically “suffered” under state and federal mandated minimum and subminimum wage rates. The federal minimum wage for nontipped workers has remained at $7.25 an hour since late July 2009, whereas the federal subminimum wage for tipped workers has remained at $2.13 an hour. Note that $2.13 is the required hourly pay for restaurants so long as servers’ reported total hourly pay — tips reported per hour plus $2.13 an hour — is at or above $7.25 an hour. If servers’ total hourly pay is less than $7.25, restaurants must make up the difference. Jayaraman’s 2015 column reported that “median pay for a tipped worker in New York [State], including [reported] tips, stands at just $9.43 an hour,” which, she argued, is significantly below a living wage in most parts of the state, especially in high-cost New York City. However, the median hourly pay of tipped workers includes workers who receive very few tips, such as at coffee shops and fast-food restaurants. Moreover, Jayaraman’s reference to the median hourly pay for servers is the hourly pay rate reported by the servers exactly halfway up the reported income ladder. If the survey includes fast-food workers, there could be many servers heavily reliant on tips who make far more than $9.53 an hour.

The most notable concern over the imposition of a broadbased mandatory wage rate is that costs of living vary by state and locality, and that types of restaurants (fast food, coffee shops, sit-down) vary within a locality. Thus, it would not make sense to mandate the same wage level.

Servers’ Attitudes toward Tipping. An informal survey of 40 servers in moderately
priced sit-down restaurants (on par with Applebee’s) was conducted in Orange County,
California. The servers were asked what hourly wage rate would they need to voluntarily forgo their current minimum wage and all tips. The hourly pay rate given ranged from $18 to $50, with a median hourly rate of $30. All the servers were quick to assert that if tipping were replaced by a fixed hourly rate of pay, service would suffer significantly, at least on average.

Restaurants’ Experience with No Tipping Policies. In late 2015, New York City-based Union Square Hospitality Group began instituting a no-tipping policy for its 1,800 employees at 13 Danny Meyer’s restaurants. Smaller restaurant companies in the Los Angeles area have also adopted no-tipping policies. Locally, the Bel Air Bar + Grill announced that it will eliminate tipping, increase employee wages and increase menu prices accordingly.

The experience of a two-restaurant firm in San Francisco provides a case study in what many restaurants might find in eliminating tipping. In 2015, the owner of Bar Agricole and Trou Normand eliminated tipping and raised prices by 20 percent to provide higher hourly wages across servers and kitchen staffers. During its 10-month experiment, the restaurants lost 70 percent of their servers. The reason was clear on reflection: Servers experienced an hourly wage drop from a range of $35-$45 to $20-$35.

The Principal/Agent Problem. Many restaurants face a serious managerial problem that economists dub the “principal/agent problem.” Many owners and corporate executives of restaurants may know a lot about the restaurant industry and their locations’ performances at the macro level — such as sales, costs, trends and industry fads. They may have demographic information about their customer bases that servers do not. But remote owners know little about individual customers in different locations across the diverse  microeconomies of their restaurant locations.

The economics of tipping can be understood in this framework. Tipping is a pay mechanism that incentivizes servers to use their localized information for their own and their company’s benefit. Tipping aligns the incentives of servers and managers and owners for a common objective — to make people’s restaurant experiences a win for everyone. Through tipping, servers effectively become commissioned salespeople, enticed to add to customers’ experience and company sales.

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