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 fiscalauthorities. 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 before and after the massive minimum wage hike that took place in Hungary in 2001 reveals that households who appear to benefit from it actually experienced a drop compared to similar but unaffected household, thus supporting the prediction of the theory.