For years tipping has been widely criticized for its detrimental effects on workers, from wage insecurity to the racist and sexist dynamics that the practice can exacerbate. Tipping generates another problem, made salient by the present COVID-19 pandemic: It often undercuts wage-based benefits for workers, including unemployment compensation.

Over 26 million unemployment claims have been filed in the U.S. in the past five weeks, the service industry among the hardest hit. Tipped workers who have lost their jobs face an especially harsh reality as many are eligible for unemployment compensation that amounts to only a small fraction of their regular earnings. In most states tipped workers are paid a subminimum wage (as low as $2.13 an hour) while the rest is made up in tips. While tips are considered wages for benefits and tax purposes, an estimated less than half of tips nationwide are reported by employers on pay stubs. The result is that critical benefits, particularly unemployment compensation, are calculated on a wage base that is considerably lower than the employee’s real earnings.

Restaurant workers in Israel might have found themselves in a similar predicament amidst the COVID-19 pandemic were it not for a critical court decision that changed the tipped income system at the start of 2019.

Tipped Restaurant Workers in Israel

In restaurants and pubs across Israel tens of thousands of workers rely on tips as a significant part of their income. Over the years, employers across the restaurant industry had implemented a variety of systems for collecting and distributing tips. Many paid workers up to the wages stipulated in their employment contract (often no more than the mandatory minimum wage) through tips and recorded that amount on their pay stubs, while the rest was given directly to workers without being reported. Because in Israel mandatory benefits like paid vacation, paid sick leave, employer contributions to pension funds and severance pay are calculated on the basis of wages as reported in pay stubs, this system afforded many tipped workers little in the way of social benefits and pension contributions. This also meant that a restaurant employee who filed for workers’ compensation or unemployment benefits received only a very small portion of his regular earnings. However, in its 2018 landmark decision (which took effect on January 1, 2019) Kis v. National Insurance Institute (available in Hebrew), the Israeli National Labor Court set a clear standard according to which restaurant workers’ tips are no different than other wages, reported or not, putting an end to a pay system that remained largely off the books and left employees with considerably less in benefits.

Kis v. National Insurance Institute

The Kis case combined two separate cases, heard together before the National Labor Court (full disclosure, at that time I was an attorney at the law firm that represented the General Federation of Labor in Israel as an amicus curiae in the case). The details of the first case sufficiently highlight the problematic nature of tipping with regard to benefits: Omri Kis was employed as a waiter in a Tel Aviv restaurant. While Kis’s pay stubs showed that he earned minimum wage, tips comprised the majority of his income. When the restaurant terminated his employment Kis filed for unemployment, and in doing so requested that his monthly compensation be calculated on the basis of his actual income, including tips, rather than the minimum wage reflected in his pay stubs. The National Insurance Institute, however, decided that unreported tips are not wages and therefore cannot be considered when calculating unemployment benefits.

Sitting as an extended panel of five judges, the court held that all tips paid in a restaurant are part of the restaurant’s revenue, even if the tips were not recorded on pay stubs, and therefore must be considered wages paid by the employer to its employees. Accordingly, a restaurant owner may not avoid paying employees statutorily-mandated social benefits by differentiating between wages and tips. Central to the court’s reasoning was the idea that tipping in restaurants is so culturally-ingrained that it cannot be seen as a voluntary act vis a vis the individual waiter but an integral part of the cost of dining out and the restaurant’s revenue. As the court explained, the amount of the tip is almost always dictated by the price of one’s order, not the quality of service (a view supported by research). Also, given that service is usually a necessary part of dining out and the restaurant’s overall revenue from customers, the court held that separating out types of remuneration for different components of the dining experience is a purely artificial distinction. Importantly, however, the court emphasized that separating tips from wages undermines the entire social security system, noting that unemployment, workers’ compensation and social security benefits are intended to allow an individual to maintain their approximate standard of living after job loss or injury.

The decision received mixed reviews from restaurant workers. Many younger workers prefer the immediate cash to longer-term social benefits and safety nets, as well as the fact that they do not pay taxes on unreported income. However, for many others (particularly outside the major metropolitan areas of Tel Aviv or Jerusalem) their restaurant job is their permanent work. Their income supports their families and the benefits are meant to ensure continued support following illness, injury or retirement. Employers for their part warned that by paying social benefits and taxes on tips they would be forced to pay workers less, or even close their doors altogether.

Looking Ahead in Israel and the U.S.

With only a bit more than a year having passed since the court’s decision took effect, it may be too soon to discern the lasting effects of the decision on the economic viability of restaurants or on wage rates in the industry. Early reports show that restaurant workers are seeing a higher wage base for benefits (as reported here in Hebrew). Additionally, organized labor in Israel claims that amidst the COVID-19 pandemic, the Kis decision has provided a critical lifeline for thousands of restaurant workers who are now eligible for unemployment compensation commensurate with their previous income, a difference of hundreds or even thousands of shekels a month.

The U.S. should implement similar standards for tipped income, even when employers fail to report it, if for no other reason than to ensure that workers can make ends meet in times of soaring unemployment. There are already some proposals on the table to that effect. According to Colorado Senator Michael Bennet’s draft proposal for federal UI standards during times of increased unemployment, compensation for tipped workers whose recorded wages are less than the state minimum wage will be calculated on the basis of the minimum wage, and tipped workers who can attest to their real earnings with tips will receive benefits calculated on the basis of those earnings. Whatever the solution, the COVID-19 pandemic has made it patently obvious that the harm that tipping practices inflict upon worker benefits is a problem that can no longer be ignored.