Both DC Restaurant-Owners and Servers Should be Worried

about Ballot Initiative 77

Jonathan Sleeper
May 27, 2018

Michael Lynn, a professor of consumer behavior and marketing at the Cornell School of Hotel
Administration, has been studying tipping in the American service and hospitality industry for
years. He is the author of the booklet, Mega Tips: Scientifically Tested Techniques to Increase
Your Tips. Dr Lynn wrote a paper in 2017 reviewing current research on the issue of tipping.
Basically, his paper is saying that if the District of Columbia passes Initiative 77 which will
increase the tipped minimum wage, restaurants in the area will become higher-priced, and the
quality of restaurant service will deteriorate. Other studies show that the employment of
restaurant servers will likely decrease, in part because of a reduction in the number of restaurants
staying in business as a result of the legislation.
Restaurant Menu Prices Will Go Up
Raising the tipped minimum wage will mean that restaurateurs will have to raise menu prices or
charge a service fee to cover increased labor costs. Remember that the restaurant industry is a
very low-margin industry (3-5 percent). This means that restaurants only get to keep three to
five cents of every dollar of revenue.
In his review of the marketing literature on restaurant tipping, Dr Lynn observes that restaurants
in New York City, Seattle and San Francisco that abolished tipping did so because of “…recent
efforts to increase the minimum wage, which many restaurateurs hope to pay for with the service
charges or higher menu prices that replace voluntary tipping” (Lynn, 2017, p. 121).
“…the evidence suggests that abandoning tipping will increase costs for, and decrease
demand from, a substantial subset of restaurant customers.” (Lynn, p. 147)
In economics, the law of demand says that when the price rises, the quantity demanded
decreases. So, when restaurant menu prices rise, the quantity of restaurant meals demanded by
consumers will decrease. Obviously, no restaurateur likes to raise menu prices. Before raising
prices or charging service fees, restaurants will try to find ways to cut back on costs: by firing
employees, not replacing employees who leave, reducing menu options, cutting back on health
insurance, cleaning the restrooms less often, cutting hours of operation, etc. These types of
responses have been documented in anecdotes about the reaction of restaurateurs in Seattle and
San Francisco to those cities’ draconian minimum wage increases here and here and here.
How Much Would Restaurant Prices Increase?
Dr Lynn cites three econometric studies that found the sensitivity of menu prices in restaurants
(what economists call “elasticity”) to be high. He suggests that a 1.0 per cent increase in prices
reduces expenditures at sit-down or full-service restaurants by 1.2 to 2.0 percent (Lynn, 2017, p.
144). Thus, a 15 per cent increase in menu prices would reduce expenditures by consumers on
restaurant meals by 19.5 to 30 percent. If an entrepreneur is selling a product with high price
elasticity, she knows that raising the price will automatically decrease revenues as customers turn
away to find another restaurant or not dine out at all.
With Service Charges Customers Will Perceive that More Restaurants Have Become “Pricey”
Most restaurant customers separate menu costs from tipping costs when they think about how
“pricey” a restaurant might be. Dr Lynn found that restaurants with voluntary tipping were
perceived as significantly less expensive than restaurants with service charges.
“Even if actual total costs to consumers are unaffected, there are reasons to believe that
replacing tipping with either higher service-inclusive menu prices or other automatic
service charges will increase perceptions of restaurant expensiveness and, thereby, reduce
demand.” (Lynn, 2017, p. 145).
This is a phenomenon that is called “price-partitioning” in market research studies, where
consumers may react favorably when the price of service or product components are separated
out (menu price and tip, refrigerator and ice-maker).
“We found that restaurants with voluntary tipping were perceived as significantly less
expensive than restaurants with service charges…Importantly, these effects held for big
and small tippers alike, which means that even customers whose total costs (including
tips) were lower under the no tipping systems thought the restaurant was more expensive
under those systems than under voluntary tipping.” (Lynn, 2017, p. 146).
So, even if the restaurant’s total charges (menu price plus service charge) are less than menu
price plus tips, customers still think they are getting ripped off.
The Quality of Servers will Decrease
The practice of tipping provides high-quality, commission-oriented professionals who help
restaurants do a better job of taking care of their customers. Lynn found that tipping motivates
servers to provide better service. His studies show that the “pay-for-performance” nature of
tipping does help attract and retain more desirable restaurant workers. Tipping means happier
customers. Dr Lynn states, “…I believe that tipping has a net positive effect on customer
satisfaction in most settings” (Lynn, 2017, p. 141).
“…servers who earn larger tips and prefer working for tips like their jobs more, think less
about quitting, and intend to stay in the job longer. These findings are all consistent with
the idea that tipping helps to attract and retain more experienced and service-oriented
workers.” (Lynn, 2017, p. 130)
Unemployment of Servers Will Probably Increase
Most economists believe that over some range of wages, the minimum wage causes
unemployment, but there is little research on the tipped minimum wage. Two studies support the
view that increases in the tipped minimum wage will cause unemployment over some range of
wages. The first study done in 2014 using Bureau of Labor Statistics data found that an increase
in the tipped minimum wage reduces overall employment in the full-service restaurant industry
and particularly for tipped employees (Even & MacPherson, 2014). Another more recent study
using W-2 data from the IRS found that employment of all restaurant servers increased at low
values of tipped minimum wage (up to $4.50 per hour) but flattened out or decreased beyond that
level (Jones, 2016). In the latter study, the increase in tipped minimum wage was directly
proportional to the decrease in tip income. Servers in this study made less overall income from
the loss of tips after the tipped minimum wage was increased.
The same authors of the first study recently completed an analysis for the Employment Policies
Institute in May, 2018, which analyzed the negative impact on employment from increasing the
tipped minimum wage on full-service restaurants in Michigan. This study also documents the
decrease in the number of full-service restaurants in 2016 in New York State, after the state
raised the tipped minimum wage by 50 percent ($5.00 to $7.50). This drop followed several
years of full-service restaurant growth in the state.
Fat Cats Don’t have to Worry
The only restaurants that don’t have to worry about Initiative 77 are the big guys. Dr Flynn
notes that “many upscale, expensive restaurants” could more easily replace tipping with higher
menu costs or service charges, as their customers tend to be “wealthier” and “less price-
sensitive,” meaning that their demand is less elastic. Smaller, struggling DC restaurants have to
worry more about Initiative 77 because their customers are more price-sensitive. They may have
a harder time staying in business once the law is passed. A recent study at the Harvard Business
School found that a one-dollar increase in the minimum wage leads to a 14 percent increase in
the likelihood of exit for a 3.5-star restaurant but has no discernible impact for a 5-star restaurant
(Luca & Luca, 2018).
DC Restaurant-Owners and Servers Should be Worried
In sum, Ballot Initiative 77 is an example of well-intentioned labor legislation having unforeseen
negative consequences on most restaurants and servers working for tips. Given the information
above, especially Dr Lynn’s marketing research on the impacts of tipping on restaurants,
customers and servers, it doesn’t make any sense for a restaurant-owner or server in the District
of Columbia to be in favor of this law. People who enjoy dining out in DC should not support it
either.
Sources Cited
Even, William E. & Macpherson, David A. (2014). The Effect of the Tipped Minimum Wage on
Employees in the U.S. Restaurant Industry. Southern Economic Journal, Vol. 80, No. 3 (January
2014), pp. 633-655.
Even, William E. & Macpherson, David A. (May, 2018). The Employment Effects of
Eliminating the Tip Credit in Michigan. Employment Policies Institute Policy Brief. Retrieved
May 26, 2018 from: https://www.epionline.org/wp-
content/uploads/2018/05/EPI_Michigan_PolicyBrief-FINAL.pdf
Jones, Maggie R. (2016). Measuring the Effects of the Tipped Minimum Wage Using W-2 Data.
Working Paper Number: CARRA-WP-2016-03. US Bureau of Census. Retrieved May 25, 2017
from: https://census.gov/library/working-papers/2016/adrm/carra-wp-2016-03.html.
Luca, Dara L. & Luca, M. (March, 2018). Survival of the Fittest: The Impact of the Minimum
Wage on Firm Exit, Harvard Business School NOM Unit Working Paper No. 17-088. Retrieved
May 25, 2018 from: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2951110.
Lynn, Michael (2017). Should US Restaurants Abandon Tipping? A Review of the Issues and
Evidence. Psychosociological Issues in Human Resource Management, 5(1), pp. 120-159.