Try smiling when you deliver the bill.

Photographer: Mark Graham/Bloomberg

Tipping Actually Makes Some Sense

Noah Smith is a Bloomberg View columnist. He was an assistant professor of finance at Stony Brook University, and he blogs at Noahpinion.
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If you want to get economics pundits excited, bring up the issue of tipping. Most of my fellow pundits despise tipping, the way they despise the Electoral College and the penny. Well, the pundits are sure to be rejoicing. Danny Meyer's Union Square Hospitality Group, which runs more than a dozen restaurant chains, just said it will eliminate tipping at all of its establishments. 

The end of tipping would bring American restaurant culture closer to the global standard. But the celebration in the press may be premature. The issue of tipping is a lot more complicated than it seems, and it isn't clear that its death would be a good thing. 

Basic economic theory gives us several reasons to like tipping. First, tips are under the table, which allows restaurants, servers and customers all to dodge a little bit of taxes. Since taxes distort the economy to some degree, theoretically this means that tipping increases efficiency. Of course, it’s unfair to allow certain types of businesses, such as restaurants, hotels and taxicabs, to selectively evade taxation. 

Another good thing about tipping is that it can make minimum wage laws less burdensome. Federal law allows restaurants to pay a lower minimum wage, a break known as a tip credit, if wait staff are expected to make up the difference in gratuities. When economists looked at what happened when the tip credit was decreased, they found that employment went down for servers. So the end of tipping culture will mean minimum wage laws take a bigger bite out of employment. That is something to think about as the nationwide campaign for $15 minimum wages gathers force. 

A third reason to like tipping is that it can be used as a reward for good service. That would be a form of pay for performance -- customers would give bigger tips to better wait staff, which would incentivize better service and draw better servers into the industry. The trouble is, both casual experience and data suggest that tips are pretty random and unfair. 

Most of the tips we leave are determined by social convention. In the past, the standard was 15 percent. These days, it’s 20 percent. That number has nothing to do with how good a server is. In addition, percentage tips are grossly unfair, since it pays lots of money to a server at an expensive restaurants and very little money to one at a cheap restaurant, even though these two servers often provide exactly the same quality of service. 

Tips are also affected by random factors such as whether the customer is paying by cash or by credit or debit card. For these reasons, many economists claim that tip size is only very weakly related to the quality of service. 

So tips may seem unfair, but probably give the restaurant industry -- and wait staff employment -- a boost. But here’s where things get complicated. Tipping also probably has a number of effects that are not captured by this tradeoff, or by standard economic theory. 

Economists typically assume that when you pay for a service, the way you pay doesn’t make a difference to you. That assumption is probably wrong in the case of tipping. When customers leave a tip, they often get a sense of satisfaction from the idea that they gave money directly to a poor, hard-working person instead of to a big faceless corporation. Many of us like knowing that some of the money we pay will go directly into the server’s pocket, instead of going through the vast, complex machinery of corporate accounting. 

Econ 101 just doesn’t deal with the personal bond that buyers and sellers can feel as the result of a transaction. But in the real world, that can make a big difference. Research shows that servers who draw smiley faces on checks get higher tips. Those customers aren’t tipping for a smiley face -- they’re tipping because it feels good to pay money to another human being with whom they feel they have shared a personal interaction. 

I believe that economics has made a big mistake by ignoring the utility humans get from the method of exchange. Tipping is just one tiny example. Personal relationships between sales workers and customers, or between purchasers and suppliers, or between bosses and employees, are emotionally important to us. A huge amount of economic activity is probably driven by that emotional importance. There’s no reason economics couldn’t take that into account, but it’s almost always ignored. 

So I think tipping is a more complicated phenomenon than the pundits believe. Standard economics simply doesn’t give us the answer. The real solution is for some businesses, such as Union Square Hospitality Group, to experiment with no-tip service, and see whether customers like it. 

Personally, I prefer to tip.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Noah Smith at nsmith150@bloomberg.net

To contact the editor responsible for this story:
James Greiff at jgreiff@bloomberg.net