An Economist’s Look at Tipping

Most of you reading this are likely familiar with the concept of tipping, but in case you’re from a region where it’s not customary (or you’ve genuinely never had to pay for a meal in a restaurant in your life), I’ll define it. Simply put, a tip is an amount of money given (usually) voluntarily by the recipient of a service to the provider in addition to the base cost and taxes. The most common example by far here in North America is tipping servers and bartenders, but it’s also considered polite to tip hairstylists, tattoo artists, and other providers of similar services. In this article, I will focus specifically on servers in restaurants as they receive 70% of tips given. For a voluntary financial transaction, tipping makes up an astounding amount of the money exchanged in the service industry; in 2013, roughly $40 billion USD was given to workers in the form of tips. There are many moral, ethical, and political arguments against tipping (it promotes discrimination, it negatively impacts restaurant functioning, it doesn’t improve service quality), and many in favour of it (particularly in the US, where the federal minimum wage for servers is frighteningly low and tips are therefore necessary for meeting basic needs). Even from an economic perspective, tipping can be construed as a positive or negative behaviour.

An argument in favour of tipping from an economist’s perspective is that it solves something called the principal-agent problem. The principal-agent problem can occur in any situation where an individual is hired to do something on behalf of someone else. You hire a realtor to sell your home, you hire a lawyer to represent you in legal proceedings, and you hire a server to wait on your restaurant’s customers. The principal-agent problem develops when the person you hire has different incentives than you. For example, when you sell your home, you want to get the highest price possible. Your realtor, however, wants to close a deal as fast as possible. Selling your home for an extra $10,000 makes a big difference to you, but not to the realtor who only makes a small commission on the sale.

How does tipping solve the principal-agent problem? Well, restaurant owners aren’t always able to directly observe servers’ performance, but customers are. In a world without tipping, it would be much easier for a server to justify doing the bare minimum at work. This is obviously not in the best interest of the restaurant owner, but it may be to the server. As some like to say, “minimum wage, minimum effort.” The presence of tipping, though, gives the server an incentive to do their best work, as doing a good job will directly reward them. It also aligns their incentives with those of the owner, since happy customers will result in repeat business and higher profits.

That’s what the theory says. However, the discipline of economics is famous for the sometimes-yawning chasm between theory and practice, and that continues here. In reality, only 1-5% of the variation in the tip amount left can be explained by the quality of service received. To put things in perspective, service quality explains less of the variation than the weather conditions during the meal, the race and gender of the server, and the quality of the food itself. None of these factors are within the control of servers.

Tipping also only solves the principal-agent problem between owners and servers, not all restaurant staff. As mentioned in the previous paragraph, food quality is a much bigger determinant of how much someone will tip than service quality, but the staff responsible for food quality aren’t tipped. Furthermore, tipping supposedly causes restaurants to struggle with keeping kitchens staffedCooking is a more specialized skill set than serving, so logic would dictate that the rate of pay for a cook would be higher. Though many restaurants do have “tip-out” policies, where servers are required to share a portion of their tips with cooks and other staff, some studies indicate that servers still make nearly double what kitchen staff make. In order to raise wages to attract more cooks, restaurants need to raise prices, as profit margins in the restaurant industry are notoriously slim. Because of tipping, price increases cost customers 15-20% more than originally intended and cost restaurants business at a commensurate rate. This completely removes the incentive to raise kitchen staff’s wages. Ironically, servers end up being the only real beneficiary of the price increase, as their tips increase in amount without any increase in effort (i.e. serving a meal takes the same amount of effort when it costs $30 as it does when it costs $25). Tipping is often looked at as a free market exchange between server and customer, but in the market for kitchen staff, it serves as a negative externality.

For all its problems, there is a reason tipping has become so ingrained in our culture. Though I mentioned that servers’ take-home pay is disproportionately high in relation to the skill required, that is not to imply that servers do not work hard for their money. They often serve as de facto therapists and babysitters and receive little in the way of benefits. If you ask anyone you know that’s ever worked as a server, they likely have more than a few horror stories regarding the level of ignorance and entitlement that exists in some people. So yes, on an economic level, tipping is a flawed practice. On a human level… tip your server.

Mallory Kroll is a fifth year Economics student and Managing Editor of The Athenaeum

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