A Pro-Growth, Progressive Alternative to “No Tax on Tips”
Replacing Income Exemptions with Dual-Ledger, Liquidity-Enhanced Retirement Accounts
Abstract: The no-tax on tips provision of the 2025 tax law is flawed policy. It is an arbitrary tax benefit favoring low-wage earners with tips over low-wage earners with ordinary wage income, and it reduces incentives for recipients to fund retirement accounts. This paper considers the merits of allowing the no-tax-on-tips provision of the tax code to lapse as scheduled in 2029 and replace it with a novel proposal to expand and reform retirement savings, while preserving cash for households.
The United States is facing an accelerating private retirement savings crisis that requires immediate structural tax reform. The upcoming 2029 sunset of temporary federal tax provisions presents policymakers with a stark choice: extend narrow, consumption-focused tax carve-outs or deploy those same fiscal resources to build a resilient, broad-based foundation of private savings.
Because federal tax expenditures are resource-constrained and federal capital is entirely fungible, the budget cannot sustain untargeted income exemptions while simultaneously expanding the domestic savings safety net. We must choose.
Prioritizing a permanent extension of the “No Tax on Tips” policy represents a significant misallocation of public funds due to several problems:
Exempting tips from federal income tax does absolutely nothing to address the structural retirement deficit. Tipped and service-sector workers are among the least prepared for retirement in the American workforce. The Bureau of Labor Statistics data shows that only about 25% of service workers -- and 23% of workers in the lowest earnings quartile -- participate in an employer-sponsored retirement plan.
Worse, a blanket income tax exemption completely fails the lowest earners. More than one-third of all tipped workers have baseline earnings low enough that they owe zero federal income tax before applying refundable credits. A “No Tax on Tips” policy provides a $0 benefit to these low-income families while scaling its upside entirely to high-income tipped earners in upscale venues. It subsidizes current consumption without building a single dollar of long-term financial security.
A tax code must maintain horizontal equity. The No-Tax-On-Tips provision violates a fundamental provision -- individuals with identical economic capacity should face identical tax liabilities. There is no economic or ethical justification for why a retail clerk, a distribution center packer, or a home health aide earning $35,000 entirely in standard hourly wages should pay higher federal income taxes than a restaurant server or bartender earning an identical $35,000 split between base wages and $5,000 in discretionary tips.
This arbitrary favoritism distorts labor markets, creates immense industry pressure to reclassify ordinary wage income as “discretionary tips” to evade taxes, and forces standard low-wage workers to subsidize their peers.
The key selling point of a “no-tax-on-tips” policy is liquidity. People reliant on tip income often face tight financial constraints and avoid saving because they cannot afford to lock up their cash. The Retirement Security Act (RSA) solves this by introducing a dual-ledger IRA system that blends complete tax deductions with immediate cash flexibility.
Under this framework, 100% of an individual’s IRA contribution is tax-deductible, but the funds are automatically split: 60% goes into a locked Retirement Reserve, and 40% goes into a completely liquid Flexible Savings ledger. Savers can withdraw from this 40% buffer at any time, permanently tax-free and penalty-free. For example, if a worker contributes $4,000 to an IRA, they get a tax deduction on the full $4,000, yet they can immediately access and spend $1,600 of it without penalty. The remaining $2,400 is locked until age 59½. This simple shift provides a powerful incentive to save for people who are liquidity-constrained, eliminating the fear of asset lock-up while firmly protecting the core retirement nest egg from premature leakage.
Traditional deductible IRAs suffer from an inherently regressive design. A high-income earner in the 32% marginal tax bracket saves $320 in immediate taxes for every $1,000 contributed, whereas a low-income worker in the 10% bracket saves only $100 for making the identical economic sacrifice. If a worker has zero income tax liability, a traditional deduction yields a $0 financial benefit.
The RSA framework completely flips this incentive structure to prioritize wealth-building at lower incomes. While high-income earners continue to receive a standard tax deduction (balanced by the new ledger rules), low-income workers qualify for a progressive federal match. Under the traditional framework, a low-income worker in the 10% bracket captures a minor $100 tax benefit per $1,000 saved, while a high-income earner in the 32% bracket extracts a $320 federal subsidy for the same contribution level.
The RSA framework changes these dynamics entirely. A high-income earner continues to receive their standard tax deduction, but a low-income worker with zero income tax liability receives a direct, 50% federal matching contribution ($500 for every $1,000 saved) deposited straight into their locked retirement core, all while keeping 40% ($400) of their own principal 100% liquid.
The combination of the progressive match and the 0% effective tax rate on the flexible buffer ensures that the federal government provides its highest aggregate subsidy rate to lower income quartiles. The credit phases down smoothly as income rises, transitioning into a standard deduction for high-income earners who utilize the account primarily for its structural liquidity advantages.
Because the 40% flexible allocation removes the primary behavioral barrier to retirement plans—the fear of asset lock-up during a financial emergency—the overall surge in both individual participation and average contribution rates across the entire economy will be substantial. Consequently, the near-term federal tax expenditure impact will be quite large, as billions of dollars in adjusted gross income are deferred from the immediate tax base by savers capitalizing on the 40% untaxed cash allowance. High-income individuals will aggressively maximize their contributions to capture the unique benefits of the liquid asset split, further compounding this near-term revenue effect.
However, this elevated public expenditure represents a high-leverage shift from consumption-side tax breaks to structural asset accumulation. A massive influx of private capital expands the domestic investment pool, reducing household dependence on state-sponsored safety nets and creating a highly resilient, self-funded workforce. Crucially, building this broad-based foundation of robust private savings serves as an indispensable prerequisite for systemic Social Security reform. By successfully engineering a parallel asset base for every American worker, policymakers will finally possess the structural flexibility and financial cushion needed to stabilize long-term public entitlement programs for generations to come.
Through this design, a worker who chooses to save does not lose their tax preference; they capitalize on it through asset accumulation. Instead of receiving a tax break when spending cash, the worker receives a functionally identical “no tax on cash” benefit when saving their income.
Appendix: Statutory Language of the RSA
Section 101. Structural Modification of Individual Retirement Accounts (IRAs)
Effective January 1, 2029, the Individual Retirement Account (IRA) architecture under Internal Revenue Code Section 408 is modified to transition individual, non-employer-sponsored retail savings into a dual-ledger system. All individual contributions are 100% deductible from adjusted gross income (AGI) in the taxable year of the contribution, up to a statutory individual limit of $7,000 (adjusted annually for inflation).
Workplace Plan Preservation: This structural modification applies strictly to individual retail IRAs. Employer-sponsored qualified retirement plans—including traditional 401(k), Roth 401(k), 403(b), and 457(b) frameworks—remain completely unchanged, operating under their existing statutory contribution limits, non-discrimination testing, and withdrawal rules.
The Bifurcated Ledger Split: Upon receipt of any individual IRA contribution, the qualifying financial institution must automatically segment the principal according to a strict 60/40 structural split:
The Retirement Reserve Ledger (60%): Formulates the locked core. To eliminate premature account leakage, funds on this ledger and all associated investment earnings are completely locked and cannot be distributed under any circumstances until the holder passes age 59½, except in cases of total permanent disability or death.
The Flexible Savings Ledger (40%): Establishes the liquid buffer. Funds on this ledger may be withdrawn at any time, permanently tax-free and penalty-free, up to the aggregate amount of the historical principal deposited.
Section 102. The Progressive Low-Income IRA Match
For single filers with an AGI below $35,000 (and joint filers below $70,000), the federal government will provide a direct, matching contribution equal to 50% of the worker’s qualified individual IRA contribution, deposited directly into the account’s locked Retirement Reserve Ledger.
Phase-Out: This matching credit phases out linearly at a rate of 5% per $1,000 of AGI above the baseline, reaching 0% at $45,000 for single filers and $90,000 for joint filers.
Workplace Exclusion: Contributions made by an employee to an employer-sponsored 401(k) or similar workplace plan are excluded from this specific retail IRA federal match mechanism, ensuring zero cross-contamination of public funding between workplace plans and individual retail accounts.
Section 103. Repeal and Transition of Special Income Exemptions
Any temporary provision excluding tip income from federal gross income calculation is repealed effective December 31, 2028. All earned income, whether received as base salary, hourly wages, or discretionary tips, shall be treated identically under the federal income tax code. Funds captured from the sunset of this exemption are structurally earmarked to fund the Section 102 low-income retail savings match.
Related Reading: For a deeper analysis of the broader legislative vehicles and budget mechanics driving these structural changes, readers should review the companion paper, Tax Reconciliation and Retirement Policy.