Tax Evasion on Gratuities

Tax evasion on tips earned by servers is a pervasive problem, one that has received almost no attention in the tax evasion literature. The authors develop a model of joint server and employer tax compliance to derive predictions for how the customer tipping rate, the server’s sales and tax rate, and the expected IRS penalty on employers influence compliance by both parties. They test the model by examining interstate differences in reported hourly pay (wages plus reported tips) during 2001. They use the Occupational Employment Statistics surveys, data on IRS regional audit rates, data from each state’s food and beverage service industry, and information on each state’s minimum wage and tax laws to perform ordinary least squares and two-stage least squares estimation. Empirical results generally provide strong support for a number of the theory’s predictions.