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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 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.

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Bibliographic Info

Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 16527.

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Date of creation: Nov 2010
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Publication status: published as "Are Household Surveys Like Tax Forms: Evidence from Income Underreporting of the Self Employed" (with Geng Li and Ben Pugsley), Review of Economics and Statistics, forthcoming.
Handle: RePEc:nbr:nberwo:16527

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  1. Gorodnichenko, Yuriy & Martinez-Vazquez, Jorge & Peter, Klara Sabirianova, 2007. "Myth and Reality of Flat Tax Reform: Micro Estimates of Tax Evasion Response and Welfare Effects in Russia," IZA Discussion Papers 3267, Institute for the Study of Labor (IZA).
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  9. Richard Blundell & Martin Browning & Costas Meghir, 1993. "Consumer demand and the life-cycle allocation of household expenditures," IFS Working Papers, Institute for Fiscal Studies W93/11, Institute for Fiscal Studies.
  10. Edvard Johansson, 2005. "An estimate of self-employment income underreporting in Finland," Nordic Journal of Political Economy, Nordic Journal of Political Economy, Nordic Journal of Political Economy, vol. 31, pages 99-109.
  11. John Fitzgerald & Peter Gottschalk & Robert Moffitt, 1998. "An Analysis of Sample Attrition in Panel Data: The Michigan Panel Study of Income Dynamics," NBER Technical Working Papers 0220, National Bureau of Economic Research, Inc.
  12. Naomi E. Feldman & Joel Slemrod, 2007. "Estimating tax noncompliance with evidence from unaudited tax returns," Economic Journal, Royal Economic Society, Royal Economic Society, vol. 117(518), pages 327-352, 03.
  13. Pierre-Olivier Gourinchas & Jonathan A. Parker, 1999. "Consumption Over the Life Cycle," NBER Working Papers 7271, National Bureau of Economic Research, Inc.
  14. Mark Aguiar & Erik Hurst, 2004. "Consumption vs. Expenditure," NBER Working Papers 10307, National Bureau of Economic Research, Inc.
  15. Clotfelter, Charles T, 1983. "Tax Evasion and Tax Rates: An Analysis of Individual Returns," The Review of Economics and Statistics, MIT Press, vol. 65(3), pages 363-73, August.
  16. Mark Aguiar & Erik Hurst, 2007. "Life-Cycle Prices and Production," American Economic Review, American Economic Association, American Economic Association, vol. 97(5), pages 1533-1559, December.
  17. Pissarides, Christopher A. & Weber, Guglielmo, 1989. "An expenditure-based estimate of Britain's black economy," Journal of Public Economics, Elsevier, Elsevier, vol. 39(1), pages 17-32, June.
  18. 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.
  19. John Gibson & Bonggeun Kim & Chul Chung, 2008. "Using Panel Data to Exactly Estimate Under-Reporting by the Self-Employed," Working Papers in Economics, University of Waikato, Department of Economics 08/15, University of Waikato, Department of Economics.
  20. 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.
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