March 27, 2024
April 1, 2024 marks the 33rd anniversary of the federal law that permits tipped workers to be paid a cash wage of just $2.13 per hour — a stunning $5.12 per hour less than the federal minimum mandated for the rest of the covered workforce.
This policy brief explains the history and mechanics of the two-tiered wage floor system along with the tip credit provision on which it relies. I examine how wage floor policies across the states and the District of Columbia vary from the federal rates.
The two-tiered wage floor system was ushered in when Congress amended the Fair Labor Standards Act in 1966. The good news was that service workers previously not covered by the FLSA, thus not covered by minimum wage laws, would be protected under the amended FLSA umbrella. But, the 1966 amendment also established a “tip credit” provision regarding the minimum wage for workers who customarily and regularly received tips — otherwise a large portion of the newly covered workforce.
How does the two-tiered wage system work; and what exactly is the tip credit allowance? At the federal level today, it works as follows:
Importantly, no actual money changes hands regarding the $5.12 tip credit. The offsetting role of tips as a replacement for the payment of wages is typically assumed. Legally, the employer must make sure the worker actually garnered enough in tips to cover the outstanding wages owed, but in practice this often does not occur. (As I’ll discuss later, this opens the door for wage theft and other issues.)
The historical trends in annual federal minimum and subminimum wages are depicted in Figure 1. In allowing the payment of a subminimum cash wage there had to be a way to get tipped workers to the legally required minimum wage, hence the tip credit allowance was created — it is the difference between the two wage floors. The arrows in the figure give examples of the tip credit as a percentage of the minimum wage at different points in time. The original 1966 FLSA Amendment stipulated that half of the minimum wage for tipped workers would be paid by employers (i.e., the subminimum cash wage) and tips would be credited towards the other half of the minimum wage obligation — a 50-50 split.
FIGURE 1:
The original tip credit was no more than 50 percent of the minimum wage, and at times it was less. But the 50-50 split was severed in 1996 when President Clinton sought to increase the minimum wage, which required Congress to amend the FLSA. That year, a deal was brokered with influence from Herman Cain, who headed up the National Restaurant Association. All agreed to an increase in the regular minimum wage from $4.25 to $5.25 in two annual steps. However, included in the text of the amendment was a provision that froze the subminimum wage, in perpetuity, at $2.13 per hour — effectively decoupling the tip credit from the minimum wage. At the time, $2.13 had already been in place since 1991 — this is how we got to 33 years and counting of a $2.13 subminimum wage.
Freezing the $2.13 subminimum wage in place meant that the tip credit allowance would increase in lockstep whenever there was an increase in the regular minimum wage — not actual cash wages paid to tipped workers. This is exactly what happened. Federally, customer tips now account for 71 percent of a tipped worker’s minimum wage, while the direct cash subminimum wage represents just 29 percent.
We are long overdue for a change in the federal wage floors. The subminimum wage (adjusted for inflation) has been on a downward trend for decades; its buying power today eroded to an all-time low. And, the minimum wage has declined by 30 percent since it was last increased in 2009; it will reach a 68-year low this year.1
|
The Racist History of the Subminimum Wage The history of paying workers little and relying on customer whims to pay all or a large share of earnings with tips was not invented in 1966. The FLSA Amendment that year followed a history deeply seated in the post-Civil War period when the idea took a firm hold in the US as employers hired formerly enslaved people but did not want to pay a fair wage. For more of this history, see The Subminimum Wage Plus Tips.2 |
With long periods of inaction, more states have instituted policies that go beyond the two federal wage floors. To get a handle on the vast array of state wage floor and tip credit scenarios, I have split them into three groups. First, I present the states that follow the $7.25 Federal minimum wage; each of these states allows for subminimum wages (i.e., tip credits). Second, I discuss the states with minimum wages higher than $7.25 that allow for subminimum wages. Lastly, I present the seven states that do not allow for a subminimum wage, and thus do not allow for a tip credit allowance.
Today there are 20 states that follow the $7.25 federal minimum wage — they are shown in Figure 2. The bar chart represents wage floor policies and tip credit allowances for each state. The dark blue portion of each bar represents the state subminimum wage, the light blue portion denotes the tip credit allowance, and the $7.25 minimum wage is noted at the end of each bar.
FIGURE 2:
Of these states, 14 of them (Alabama, Georgia, Indiana, Kansas, Kentucky, Louisiana, Mississippi, North Carolina, Oklahoma, South Carolina, Tennessee, Texas, Utah, and Wyoming) follow the federal policy of a $7.25 minimum with a $2.13 subminimum wage. Thus, tips subsidize $5.12 for each and every hour that a tipped worker works in these states.
An additional six states have minimum wages set at $7.25 coupled with subminimum wage policies above the $2.13 federal rate — they range from $2.33 in Wisconsin to $4.86 in North Dakota. Tip credit allowances for these six states range from a high of $4.92 in Wisconsin to a low of $2.39 in North Carolina.
The federal minimum wage is still relevant today as 40 percent of states adhere to it. The lowest-wage workers in these 20 states deserve a long overdue raise. In Mississippi, for instance, 29 percent of its workforce is paid less than $15 per hour — that figure is also high for Alabama (22 percent), Arkansas (23 percent), Louisiana (27 percent), and Oklahoma (24 percent).3
States that comprised the second set are those that have minimum wages higher than $7.25 and also allow for subminimum wages by granting tip credit allowances. Figure 3 shows the policies for the 24 states that meet these criteria. They are sorted from highest to lowest minimum wage rates.
FIGURE 3:
The average minimum wage and subminimum wage for these 24 states are $13.20 and $6.10, respectively. The averages are much higher than the federal policies with substantial variation. Minimum wages range from $8.75 in West Virginia to $17.00 in the District of Columbia. Subminimum wages span the federal policy of just $2.13 in Nebraska and Virginia to $12.75 in Hawaii. The average tip credit is $7.10 for this group with a low of $1.25 in Hawaii and a high of $11.37 in Maryland. Maryland’s tip credit is the largest tip credit ever recorded.
The seven remaining states are referred to as “no tip credit” or equal treatment states. They all have minimum wages much higher than the federal rate and they do not allow tipped workers to be paid a subminimum wage rate (i.e., no tip credit allowance). Thus, the bars that represent each of the states in Figure 4 are all dark blue, signaling that all workers are paid the binding state minimum wage, and employers are not granted a tip credit. In these seven states, all tips are gratuity on top of being paid the minimum wage.
FIGURE 4:
Minimum wages across these seven no tip credit-states average $12.94; ranging from $10.30 in Montana to $16.28 in Washington. To the best of my knowledge, these states never had subminimum wages but have always had full-service restaurants and tipped workers. Many chain restaurants exist across all of the policy scenarios, an indication they have adopted profitable business strategies that are successful across high- and low-road policy scenarios.
The mathematical relationship between the minimum wage, subminimum wage, and the resultant tip credit amounts varies widely across the US. The first map shown in Figure 5 gives the dollar amount of state tip credits — recall these figures represent the dollar amounts that employers are not paying in actual wages to their tipped workers, but instead are credited as a wage subsidy via customer tips.
FIGURE 5:
There is a vast range in allowable tip credit amounts across the US — from zero to $11.37 per hour. The seven no tip credit-states are gray in Figure 5 as they do not allow for a tip credit. The states with tip credit allowances are in shades of purple with the darkest representing the highest tip credit dollar amounts. The calculation of the tip credit for each state (i.e., MW − SubMW = TC) is accessible by hovering a cursor over each state. Today across the US we are experiencing some of the largest tip credit amounts ever recorded. Why are we seeing this now? It is because some states have adopted more generous minimum wage policies but have allowed for relatively low subminimum wages that resulted in large tip credits.
Some of the largest tip credits in dollar terms are in progressive-leaning states that have increased minimum wages but left subminimum wage policy little or unchanged. For example, when Maryland increased its minimum wage from $13.25 to $15.00 on January 1, 2024, they kept their subminimum fixed at $3.63. While the lowest earners in the state got raises, that was not the case for tipped workers. Why? Because the subminimum wage stayed the same at $3.63, meaning their cash wage did not increase at all. It was the “credit” of wages via tips that grew from $9.62 to $11.37 — resulting in the largest tip credit ever recorded in the US. This policy change meant that employers of tipped workers went from a 72.6 percent wage subsidy via tips provided by the public to 75.8 percent. Conversely, the relative cash wage paid by employers fell from 27.4 percent of the old minimum wage to 24.2 percent of the new one.
Maryland is followed by Delaware and Rhode Island for the next largest tip credits — $11.02 and $10.11, respectively. It can’t be stated enough: This customer-provided subsidy is credited as wages by employers of tipped workers for each and every hour that they work.
Other somewhat surprising examples of large tip credits are in states like Nebraska and Virginia — both followed federal wage policy until 2014 and 2021, respectively. Today they each have $12.00 minimum wages coupled with subminimum wages that follow the $2.13 federal policy — leaving tip credits of $9.87 in each state. Nebraska is slated to raise its minimum to $15 the first day of 2026, but it plans to keep the $2.13 subminimum in place. Such a policy would represent a $12.87 tip credit that would cover 85.8 percent of wages due to tipped workers in the state leaving employers to pay cash wages that cover just 14.2 percent of the minimum wage due to tipped workers.
The map in Figure 6 gives the tip credit as a percent of the minimum wage for each state; in other words, it represents the percentage of the minimum wage that employers are able to pass on to the public via tips. Again, the seven states without a tip credit are in gray as they pay the full minimum wage. As mentioned, the federal tip credit is $5.12 which represents 70.6 percent of the federal $7.25 minimum wage; conversely the cash wage represents 29.4 percent (in states like Alabama, Texas, and Utah for example).
FIGURE 6:
Just as tip credit dollar amounts have risen to levels never experienced before in the US, so too have tip credit percentages as a share of minimum wages. For example, Delaware has the largest at 83 percent, meaning employers are only responsible for paying a cash wage that represents just 17 percent of Delaware’s $13.25 minimum wage. The 83 percent represents an enormous subsidy to employers of the tipped workforce. Next are Nebraska and Virginia, both with tip credits of 82.3 percent; otherwise, a $9.87 tip credit.
The changing landscape of state wage floors, along with tip credit provisions, across the US represents a sort of experiment that has evolved over the last few decades. Today the array of combinations presented in this brief may be generally summarized in buckets of low-road (Figure 2) and high-road (Figure 4) with a bunch of mixed policies (Figure 3) in-between. The federal wage floor policy represents a low-road policy and is long overdue for significant change. The federal policy is important, given that two of five jobs in the US are in the states that have a $7.25 minimum wage. High-road policies are the seven that have minimum wages much higher than the federal rate and do not allow for a subminimum wage — where all tips are gratuity on top of binding minimum wages.
The mixed group consists of states like Ohio that have a $10.45 minimum wage with a $5.25 subminimum wage that leaves a $5.20 tip credit — close to a 50-50 split like the original federal policy — but leaving much room for improvement. Maryland is also mixed in that it has a relatively high $15.00 minimum wage coupled with a $3.63 subminimum wage — which represents the highest tip credit dollar amount ever recorded in the US. Other states include Delaware, Nebraska, and Virginia that have the three highest tip credit percentages at 83 percent, 82 percent, and 82 percent, respectively. These represent enormous wage subsidies provided via customer tips to employers, while they pay cash wages of just 17 percent to 18 percent of the minimum wage. If employers paid no portion of the wages due to tipped workers, would that be okay?
Too many tipped workers are completely left behind when the minimum wage is increased but the subminimum cash wage is left unchanged. In this circumstance, the reliable cash wage is unchanged for tipped workers, but the tip credit subsidy afforded to employers increases in lockstep with the minimum wage increase. This is what happened when the federal subminimum was frozen at $2.13 in the 1996 FLSA amendment. The tip credit increased from 50 percent to 71 percent of the minimum wage as subsequent increases in the minimum wage were passed, while the $2.13 cash wage has remained unchanged for 33 years.
Compliance is difficult as it requires a complex accounting system and opens the door to wage theft. As tip credit amounts have become larger, the legal requirement that tips plus the cash wage must equate to at least the minimum wage is more likely to fall short. Today tip credits are at least $6.00 per hour in over 16 states, $9.00 in 11 states, and all the way up to $11.37 in Maryland.
The Department of Labor states that employers claiming a tip credit must be able to show in each workweek that tipped employees receive at least the full federal minimum wage when direct cash wages and tips are combined.4 In practice, it is largely left to tipped workers, who typically must approach the manager if they are owed money. Workers may face retaliation — they could be fired or moved to slow shifts — making workers fearful of confronting a manager. It is simply wrong to have workers overseeing compliance. Tipped workers need a voice at work, but just 1.6 percent of workers in food services and bars are represented by a union — far less than the already low rate of 6.9 percent for the US private sector.
Other issues are often ignored. For instance, waitstaff often “tip-out” other workers who help them do their job. For example, waitstaff often tip-out bussers and hosts who are typically minimum wage earners. These secondary tips may comprise a large share of tips received by a tipped worker.
As I reported in my 2023 paper on this subject, labor market protections and policies matter. The experience of a tipped worker who works in a state with a $2.13 cash wage is far different than one working in a state without a subminimum wage and a higher minimum wage. The Bureau of Labor Statistics reported in 2019, prior to the pandemic, that the median earnings of waitstaff (the single largest tipped occupation) were 40 percent higher in the seven states with no tip credits and relatively high minimum wages compared to the states with a $2.13 subminimum wage. This difference was twice as high compared to the 20 percent difference in median wages across all workers between these two groups of states.
There are also significant differences in poverty rates for tipped versus non-tipped workers. As reported by my colleagues at the Economic Policy Institute, poverty rates for waitstaff and bartenders were 18.5, 14.9, and 11.1 percent, on average, across low- middle- and high-road policy states. While the corresponding poverty rates for the non-tipped workforces were 6.7, 5.7, and 6.2 percent, respectively.5
Tipped workers tend to also have low-quality jobs — meaning they lack access to benefits such as paid sick leave, holiday pay, employer-provided health care, and/or retirement benefits — all the more reason they need a reliable living wage. Tipped workers often experience large and unexpected fluctuations in earnings by simply being scheduled for a different shift — same job, same restaurant but with extreme pay volatility depending on scheduled hours and days of work. Someone always has to work the slow shift, the overnight shift, or the day the temperature is below zero. Sure, some tipped workers make a lot of money via tips regardless of the state where they work, but those represent a small share of tipped jobs. In full-service restaurants, those lucrative jobs often go to the small minority of men who are waitstaff.
It is past time that we rethink the subminimum wage and the tip credit allowance, especially in light of the deeply troubling racist history of post-Civil War employers who hired formerly enslaved workers but did not want to pay a living wage.6 Instead, they opted for mostly white customers to determine how to compensate workers via voluntary and unpredictable tips. Given the vast array of policies across the US, it is clear we can and should do better. This two-tiered wage floor system, which hinges on allowing employers to take a “tip credit” to skirt paying wages, does not exist in other countries — and it should not exist in the US.
