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What are the fiscal implications of minimum wage?

25.09.2007
What is shown is that the minimum wage acts as a constraint on the tax evasion decision and induces an increase in compliance by some agents, while pushing others out of the formal labour market into the black economy or into inactivity.

What are the fiscal implications of introducing or increasing the minimum wage? How can we explain the very high spike at the minimum wage level appearing in the wage distribution of some countries? What is the effect of in-work benefits in labour markets characterized by search frictions? Is their impact on labour market variables like unemployment and labour force participation stronger or weaker once we account for their financing? These are some of the issues addressed by Mirco Tonin in his dissertation at the Institute for International Economic Studies, Stockholm University.

The first set of questions is addressed by looking at the interaction between underreporting of earnings by employed labour and minimum wage legislation from a theoretical and empirical perspective. Tax evasion by employed labour in the form of underreporting of earnings to fiscal authorities is particularly common in Eastern Europe and the Former Soviet Union, but also in countries like Turkey, Argentina and Italy. What is shown is that the minimum wage acts as a constraint on the tax evasion decision and induces an increase in compliance by some agents, while pushing others out of the formal labour market into the black economy or into inactivity.

"The overall effect when enforcement is not too effective is to unambiguously increase fiscal revenues. The distribution of the fiscal burden is also altered, turning a nominally neutral fiscal regime into a regressive one. Moreover, an otherwise smooth distribution of declared earnings is transformed into a distribution presenting a spike at the minimum wage level," says Mirco Tonin.

Another prediction of the theory is that a minimum wage hike implies a fall in true income also for workers who appear to benefit from the hike, as they keep their job and experience an increase in official earnings. This prediction is tested by using the massive increase in the minimum wage that took place in Hungary in 2001 as a quasi-natural experiment. The empirical approach used is to compare food consumption before and after the minimum wage hike by households affected by it to food consumption by similar but unaffected households. The test supports the prediction of the model, showing that the minimum wage hike was indeed instrumental in increasing compliance with fiscal regulation.

The last chapter, co-authored with Ann-Sofie Kolm, looks at the impact of in-work benefits in labour markets characterized by search frictions. In-work benefits are increasingly popular among policy makers and they are usually introduced to "make work pay": by supplementing low wages, they provide employment incentives. The paper looks at the impact of benefits once their effect on wages and their financing are accounted for. What is shown is that introducing or increasing in-work benefits increases labour force participation, employment, and search intensity by unemployed, while wages and the unemployment rate decline. The impact of benefits on job creation is an important factor behind employment growth.

"The analysis of financing reveals that increasing in-work benefits financed through a proportional tax rate is equivalent to reducing the "effective" bargaining power of the worker. The conditions under which labour force participation, employment, and search intensity by the targeted group improves as a result are identified." says Mirco Tonin.

Title: "Essays on Labour Market Structure and Policies"

Further information
Mirco Tonin, The Institute for International Economic Studies, Stockholm University, tel. +36 20 4250025 and +44 78 24712760, e-mail Tonin@iies.su.se, M.Tonin@soton.ac.uk.

Pressofficer Maria Sandqvist; maria.sandqvist@eks.su.se; +46-70664 22 64

Maria Sandqvist | idw
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