Scandinavian Working Papers in Economics

Working Paper Series, Center for Fiscal Studies,
Uppsala University, Department of Economics

No 2015:2: Income underreporting among the self-employed: a permanent income approach

Per Engström () and Johannes Hagen ()
Additional contact information
Per Engström: Uppsala Center for Fiscal Studies, Postal: Department of Economics, Uppsala University, P.O. Box 513, SE-751 20 Uppsala, Sweden
Johannes Hagen: Uppsala Center for Fiscal Studies, Postal: Department of Economics, Uppsala University, P.O. Box 513, SE-751 20 Uppsala, Sweden

Abstract: The consumption based method to estimate underreporting among self-employed, introduced by Pissarides andWeber (1989), is one of the workhorses in the empirical literature on tax evasion/avoidance. We show that failure to account for transitory income fluctuations in current income may overestimate the degree of underreporting by around 40 percent. Previous studies typically use instrumental variable methods to address the issue. In contrast, our access to registry based longitudinal income measures allows a direct approach based on more permanent income measures. This also allows us to evaluate the performance of a list of instruments widely used in the previous literature. Our analysis shows that capital income is the most suitable instrument in our application, while education and housing related measures do not seem to satisfy the exclusion restrictions.

Keywords: Income underreporting; tax evasion; self-employment; Engel curves; permanent income

JEL-codes: D12; H24; H25; H26

24 pages, June 15, 2015

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