Tuesday, May 31, 2011

Minimum wage and tax evasion

While the minimum wage is seen by many as an easy way to prevent poverty, it has its pitfalls. Apart from the fact that it may increase unemployment, it may lower wages and attract more immigrants. Now add to this that minimum wages may decrease disposable income and thus consumption.

Mirco Tonin looks at the case of a country with a significant underground economy. As only declared labor income is taxed, introducing a minimum wages means that everyone must declare at least the minimum wage as income. For at least some people this will reduce disposable income. Now increase that minimum wage, then everyone who was declaring such an income has to pay more taxes. Is this significant? Tonin looks at Hungary where there was a significant increase in the minimum wage in 2001 and it is believed half of those declaring minimum wage on their tax return actually earn more. Looking at the gap between consumption and income on household data, a common way to identify underground income, he finds that the effect on consumption was quite significant for those who were affected by the minimum wage hike.

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