What we pay in the shadows: Labor tax evasion, minimum wage hike and employment

Abstract

The interactions between minimum wage policy and tax evasion remain largely unknown. We study the firm-level employment effects of a large and biting minimum wage increase in the context of widespread wage underreporting. We apply machine learning to classify firms as either tax-compliant or tax-evading. We then show that firms engaged in labor tax evasion are insensitive to the minimum wage shock. Our results indicate that these firms use wage underreporting as an adjustment margin, converting part of their formerly undeclared cash payments into official wages. Increasing the minimum wage improves tax enforcement, but comes at the cost of negative employment consequences for compliant firms.