Tips versus Higher Wages: Data, Theory, and Simulations

he law permits employers to pay tipped employees below the full minimum wage. I investigate a policy whereby income collected from tips is replaced by a higher minimum wage for tipped employees. In a fully-served market, this transition makes both employers and servers better off while consumers end up paying higher prices for the service. Under local monopolies, this transition may result in some loss of employment. Replacing tips with higher wages raises employers' artificially-low hourly labor cost to their actual levels thereby inducing employers to increase consumer prices. Simulations based on actual data are then used to test some of the model's predictions.