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Are household surveys like tax forms: evidence from income underreporting of the self-employed

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  • Erik Hurst
  • Geng Li
  • Benjamin Pugsley

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 also systematically underreport their income in 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. Failing to account for such income underreporting leads to biased conclusions. We document this bias in existing measures of earnings differentials, wealth differentials, precautionary savings, lifecycle earnings profiles, and earnings variation across MSAs. Our results show that it is naive for researchers to take it for granted that individuals will provide unbiased information to household surveys given their demonstrated tendency of providing distorted reports of the same information to other administrative sources.

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Bibliographic Info

Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2011-06.

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Date of creation: 2011
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Handle: RePEc:fip:fedgfe:2011-06

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Keywords: Households ; Self-employed ; Income ; Disclosure of information;

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  1. Marco Cagetti & Mariacristina De Nardi, 2003. "Entrepreneurship, frictions, and wealth," Staff Report 322, Federal Reserve Bank of Minneapolis.
  2. J. Fitzgerald & P. Gottschalk & R. Moffitt, . "An Analysis of Sample Attrition in Panel Data: The Michigan Panel Study of Income Dynamics," Institute for Research on Poverty Discussion Papers 1156-98, University of Wisconsin Institute for Research on Poverty.
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  9. Mark Aguiar & Erik Hurst, 2008. "Deconstructing Lifecycle Expenditure," NBER Working Papers 13893, National Bureau of Economic Research, Inc.
  10. Erik Hurst & Annamaria Lusardi, 2004. "Liquidity Constraints, Household Wealth, and Entrepreneurship," Journal of Political Economy, University of Chicago Press, vol. 112(2), pages 319-347, April.
  11. Bonggeun Kim & John Gibson & Chul Chung, 2009. "Using Panel Data to Exactly Estimate Income Under-Reporting by the Self Employed," Labor Economics Working Papers 22996, East Asian Bureau of Economic Research.
  12. Gourinchas, Pierre-Olivier & Parker, Jonathan A, 2000. "Consumption Over the Life-Cycle," CEPR Discussion Papers 2345, C.E.P.R. Discussion Papers.
  13. Steven D. Levitt & John A. List, 2011. "Was There Really a Hawthorne Effect at the Hawthorne Plant? An Analysis of the Original Illumination Experiments," American Economic Journal: Applied Economics, American Economic Association, vol. 3(1), pages 224-38, January.
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  15. Bruce D. Meyer & Wallace K. C. Mok & James X. Sullivan, 2009. "The Under-Reporting of Transfers in Household Surveys: Its Nature and Consequences," NBER Working Papers 15181, National Bureau of Economic Research, Inc.
  16. Mark Aguiar & Erik Hurst, 2004. "Consumption vs. Expenditure," NBER Working Papers 10307, National Bureau of Economic Research, Inc.
  17. Rebecca M. Blank & Kerwin Kofi Charles & James M. Sallee, 2009. "A Cautionary Tale about the Use of Administrative Data: Evidence from Age of Marriage Laws," American Economic Journal: Applied Economics, American Economic Association, vol. 1(2), pages 128-49, April.
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  20. John Gibson & Bonggeun Kim & Chul Chung, 2008. "Using Panel Data to Exactly Estimate Under-Reporting by the Self-Employed," Working Papers in Economics 08/15, University of Waikato, Department of Economics.
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