Monday, August 11, 2014

Tipping at Restaurants Does Not Make Economic Sense, But Should We Ban It?

In many restaurants in America, one is served their food by a waiter or waitress. After the meal, one is expected to pay a certain amount of money for a service charge, which is known as a tip or gratuity.  The premise of this social custom is to compensate service workers (and in this case, waiters and waitresses) since they are paid $2.13 per hour and have to rely on good tips to help make ends meet. Gratuity is meant to be an act of altruism. However, I have to say that I am annoyed by this non-optional social convention, especially after listening to this Freakonomics podcast and reading up on tipping research.

What's the issue with tipping? For starters, it's a practice that parades itself as the fa├žade of being an option, but unless you don't care at all what other people think, it's a de facto quid pro quo arrangement. Although some people tip because they get a kick out of it (Lynn and Wang, 2013), most people do so not because of altruism or compassion, but because of social pressure, guilt, and embarrassment (Azar, 2008), which creates a negative externality. Although there is an incentive to free ride and pay next to nothing on the tip (Margialoth, p. 122) when you're not going to return to the restaurant (not to mention that you're not legally obligated to pay the tip), it would explain why many people still tip. We don't want to come off as stingy or frugal, and gratuity somehow seemingly abates that. Plus, there is the idea in longer-term game theory (i.e., people expect better service next time they return), it can provide an incentive for the server to do a better job next time. Additionally, servers do not have a consistent wage, but they can better evade taxes (Estreicher and Nash, 2004). There is also the matter that the practice has a racial component. Some empirical evidence shows that African-Americans are perceived to tip less, which means poorer quality service (Nash and Pugh, 2012). This ends up creating a racial disparity in restaurant service.

People can do their job just fine without tips. There is little evidence that the tipping system is particularly effective. Providing very good service only gives about a two percent bump in one's tips (Lynn, 2003), which just tells me that tipping is not performance-based, but typically based on the size of the check (Margialoth, p. 125). This means that tipping does not save on service-monitoring costs, and instead creates market inefficiencies (ibid., p. 126) because it "exerts indirect upward pressure on spending by the median earner....which results in overconsumption, less leisure time, and overall decreases in welfare (ibid., p. 127)." This would also mean that a transaction with unfair values took place, which is unfair to the customer.

On a personal level, I think that we should get rid of tipping. This makes me ask the question of how to address the issue. For the most part, this is not an issue created by the government. Granted, the government sets the minimum wage for servers at $2.13, which indirectly perpetuates the practice, as does the fact that employers also benefits from the current tipping system by paying less taxes (Margialoth, p. 133). However, this is primarily a market failure. Without the government changing the minimum wage of the server, the only other alternatives for businesses to implement are service-inclusive pricing or a service charge. Each business practice comes with its advantages and disadvantages. I think service-inclusive pricing is most fair because it includes all labor costs in the pricing, but customers could complain because of perceived, albeit inaccurate, unfair pricing. Why they would complain if the net amount spent is comparable is beyond me, but maybe the irrationality is that it's more disconcerting for a customer to see it as a service fee or to see food prices to increase than to remove the current system. Ultimately, we have the freedom to practice whichever forms of altruism the way we want. Imposing minimum wage laws or irrational social norms is not the way to go. Putting an end to tipping in our personal lives will force restaurants to switch over to service-inclusive pricing, which will improve the restaurant industry in the long-run.

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