Minimum wage and tax evasion: Theory and evidence

This paper examines the interaction between minimum wage legislation and tax evasion by employed labor. I develop a model in which firms and workers may agree to report less than the true amount of earnings to the fiscal authorities. I show that introducing a minimum wage creates a spike in the distribution of declared earnings and induces higher compliance by some agents, thus reducing their disposable income. The comparison of food consumption and of the consumption–income gap before and after the massive minimum wage hike that took place in Hungary in 2001 reveals that households who appeared to benefit from the hike actually experienced a drop compared to similar but unaffected households, thus supporting the prediction of the theory.

Research highlights► I model the interaction between minimum wage and tax evasion by employed labor. ► Introducing a minimum wage creates a spike in the distribution of declared earnings. ► A minimum wage induces higher compliance by some and reduces their disposable income. ► I use the minimum wage hike that took place in Hungary in 2001 as a quasi experiment. ► The analysis of food consumption and the consumption–income gap supports the theory.