Put aside the question of why customers give tips. That’s certainly a huge mystery but the fact is that many diners give tips and the level of tip depends on the quality of service.
In this article (via foodwire), a restauranteur explains why he decided against a switch to the European system of a fixed service charge.
We looked very hard at this [servis compris] policy fifteen years ago. We were going to call it “hospitality included.” We felt people who worked in the dining room were apologizing for being hospitality professional. I felt there was a resulting shame or lack of pride in their work. My assumption was that it was fueled by the tipping system, and I was troubled by the sense that the that tipping system takes a big part of the compensation decision out of the employer’s hands. So we brought up the “hospitality included” idea to our people. To our surprise, it turned out the staff actually enjoyed working for tips.
The tipping system encourages servers to put more weight on the diner’s welfare than the restauranteur would like, at least at the margin. You can think of the waiter as selling you extra bread, more wine in your glass, and more attention at the expense of less generous (-looking) diners. The restauranteur incurs the cost but the server earns the tip.
On the other hand, a fixed service charge provides too little incentive to take care of the customers. You can think of a tipping system as outsourcing to the diner the job of monitoring the server.
(I once had a conversation on this topic with Toomas Hinnosaar and I am probably unconsciously plagiarising him.)
Cheap Talk 
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September 23, 2009 at 11:51 pm
Thorfinn
A good tipping system requires flexibility in tipping. The custom of always tipping 15 percent or so is no different from the fixed service charge, but with some ugly commoditized human relations on top.
September 24, 2009 at 2:09 am
Sam
I used to work in restaurants, and given the choice I would never have opted to work for a service charge because it moves the power of what gets done with the tip from the wait staff to the restaurant. In the uk, where service charges are commonplace, they are often used to pay the wages of the entire restaurant (and subject to tax to boot). Wait staff in (mid-range) places without service charges earned 50 to 100% more than those in places with them. This was at least the case five years ago while I was at college.
September 24, 2009 at 8:44 am
RestaurantZoom
A professional waitstaff person explained to me like this: “TIPS – to insure proper service” Of course, the concept fits even though the letters don’t quite work ie; insure vs ensure, but regardless, waiting tables is all about the one on one relationship and the performance of the wait person with regard to expectations. Personally, we start out walking in at 20% of the check or what the check should be without any discounting. Then we go up or down from there depending on the experience. Most of the time it stays at 20%, but at others we have had horrible service and left nothing. Our feeling is that they ruined our meal experience so really they should have been paying us to put up with them! This has only happened 2-3 times in my life (thank God). Some have earned much more…They so enhanced our experience that the meal would not have been near as enjoyable without them:-)
September 24, 2009 at 12:48 pm
Brandon
Tipping is a great example of the allocation of inalienable decision rights (rights over human capital/servicel) and payoff rights (variable vs fixed payoffs). The relevant question then is: why is Europe different from the US? And which system is more efficient in terms of total surplus (presuming neither are first best)? I have no idea. Any thoughts?
October 4, 2009 at 10:29 pm
Series: ‘Round the Web « UES Marketplace
[…] 1. Professor Jeff Ely explores why Americans still tip. Cheaptalk […]
March 12, 2012 at 11:04 am
Mike S.
Tips are nothing more and nothing less than a hand out, a free ride, a subsidy veiled as tipping, at the expense of customers who pay enormous amounts of money especially at pricey restaurants which earn millions in revenue. Given this simple fact, its clear that tipping is a subsidy. Do owners really need it. It’s one thing to tip out of courtesy, but its a totally different issue when restauranteurs pay their wait staff less than minimum wage then expect diners to make up for wages that are indeed their responsibility. There are many other industries where tipping also make sense but this idea of reducing wages and expect for customers to make up the difference by paying tips is clearly unscrupulous.