America’s system of tipping at restaurants defies all economic logic

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Tipping is terrible. It’s bad for all but the highest-paid servers. The American public seem to be increasingly disillusioned with it, too: According to a 2017 YouGov poll, 44% of Americans are in favor of doing away with tipping altogether and paying waiters higher wages instead, while 36% want the system to stay the same.

Now residents of Washington, DC, have a chance to change the way restaurants work. On Tuesday (June 19) residents vote on Initiative 77, which would eliminate tipping in restaurants and replace it with a $15 minimum wage for servers. Currently, servers in DC get $3.33 an hour, plus tips. If the tips fall short of $12.50 an hour, restaurants make up the difference.

From an economic standpoint, it’s safe to say that eliminating tipping is definitely the right move. The much harder question is how to calculate the right minimum wage to replace tips.

The strange, terrible economics of tipping

Most Americans think of tipping as an economic transaction between the customer and the server, in which the server is held responsible for the quality of the dining experience and rewarded or punished accordingly. This is incorrect. The service a diner receives is the product of the entire restaurant staff; a particularly efficient prep cook or bumbling dishwasher can make a big difference.

Yet tips mostly compensate the server. This distinguishes restaurants from most other businesses. In any other industry, company owners ration revenue based on the skills, scarcity, and value added of each staff member. But in American restaurants, convention and regulation, rather than economics, dictates how revenue is divided. As a result, chefs—who have specialized training and skills—earn a fraction of what servers are paid in many fine dining restaurants. Research estimates front-of-the-house staff makes 80% more than kitchen staff in fine-dining restaurants.

The tipping system works out great for servers in fine-dining restaurants, who can make more than $100,000 a year. But in most restaurants, servers barely get by. They also bear the risk of a slow night or a table that lingers for hours and barely orders any food. If they simply got paid a normal salary, they’d have more predictability, and be better equipped to figure out how to manage their budgets. (Under current DC law, servers have a bit more stability, since restaurant owners top up slow tip days to $12.50 an hour. But some DC employers violate that rule, and plenty of other places in the US don’t have such high minimums.)

Does getting rid of tips hurt restaurants?

Most restaurants in DC oppose the proposal to end tipping. That’s because restaurants typically operate on thin margins. To pay the staff higher wages, they’ll need to raise menu prices, which they worry will be bad for business.

It is probably true that restaurants will be forced to raise prices—but that does not necessarily mean that all customers will actually wind up paying more for their meals. It depends on what kind of tippers they are, and the type of restaurant they frequent.

About 66% of restaurant customers tip 20% or more, according to Michael Lynn, a marketing professor at Cornell University who researches tipping. If a restaurant needs to increase prices by 20% in order to pay servers at least $15 per hour, that suggests 66% of customers would be fine with the change, while the other 44% of customers could be less inclined to eat out, according to Lynn. If restaurants need to increase prices even more to pay at least $15 an hour, they stand to lose even more business.

The cheaper restaurants will probably have to hike up menu prices more, since smaller bills mean smaller service charges. They also have more price-sensitive customers. So it’s the lower-priced restaurants that face the most potential risk.

The right minimum wage

And so how much damage eliminating tipping does to restaurants depends mostly on the minimum wage that replaces the tips. In the case of DC, most restaurants and servers wouldn’t see an immediate effect. The minimum wage would start at $12.50—what servers are paid now, including tips—and be phased in over the next seven years.

But as the wages increased, the effects on restaurants and workers would be less certain. Profitable restaurants would probably be able to absorb higher costs; restaurants with lower margins (that is, most businesses) would need to increase prices. Whether this would mean fewer jobs is unclear. Evidence suggests higher minimum wages may reduce some teen employment. Generally, small wage increases don’t have much impact; less is known about large increases.

Whether a $2.50 increase, over a seven year period, is large or small depends on what happens to the DC economy in the next seven years. A recession, which makes customers more price-sensitive, coupled with higher server wages could be catastrophic for restaurants. A strong economy would probably mean bigger restaurant profits, and perhaps even wage increases that go beyond the minimum.

There are alternative options that could expose restaurants to less risk, like making wage increases contingent on economic conditions. But the DC proposal is a step in the right direction: It would give equity to kitchen staff, and strike a blow against tipping tyranny.

qz.com