Minimum wage spike and income underreporting: A back-of-the-envelope-wage analysis

The labor markets of many transition countries are characterized by two features: a spike at the minimum wage in the wage distribution and a widespread use of so-called envelope wages, i.e., non-declared cash coming in addition to the official wage. In this paper, we present a body of suggestive evidence highlighting the prevalence of wage underreporting among minimum wage earners. We study two minimum wage hikes implemented in Latvia in 2014 and 2015, and show that minimum wage employees are more likely to survive these minimum wage hikes than employees earning slightly more. This effect is present in the sample of small (more prone to tax evasion) firms and is not found in the sample of big (less prone to tax evasion) firms. In addition, we show that minimum wage earners switching from employment in a small to a big firm enjoy a significantly larger wage gain than employees earning slightly more. Taken together, these results are consistent with tax evaders being overrepresented among minimum wage earners and are hard to rationalize otherwise.