Are Household Surveys Like Tax Forms: Evidence from Income Underreporting of the Self Employed

Abstract

There is a large literature showing that the self employed underreport their income to tax authorities. In this paper, we quantify the extent to which the self employed systematically underreport their income to U.S. household surveys. To do so, we use the Engel curve describing the relationship between income and expenditures of wage and salary workers to infer the actual income, and thus the reporting gap, of the self employed based on their reported expenditures. We find that the self employed underreport their income by about 30 percent. This result is remarkably robust across data sources and alternative model specifications. Aside from transportation expenditures, we find little evidence that the self employed misreport their expenditures to household surveys. We show that failing to account for such income underreporting leads to biased conclusions when comparing the earnings and saving behavior between the self employed and other workers as well as biased estimates of the importance of precautionary savings, the shape of lifecycle earnings profiles, and the magnitude of earnings differences across MSAs. Finally, our results show that it is naive for researchers to take it for granted that individuals will provide unbiased information to household surveys when they are simultaneously providing distorted information to other administrative sources.