Underreporting of earnings and the minimum wage spike

This paper contributes to the policy debate on minimum wage by highlighting its role in enforcing compliance with fiscal rules in economies where underreporting of earnings is widespread. First, I propose a simple model exploring the interaction between the minimum wage and underreporting of earnings. Then, I provide supportive evidence by documenting a positive correlation within European labour markets between the proportion of full-time employees with earnings on the minimum wage and the extent of underreporting of earnings in the economy. The analysis presented in this paper suggests that a high spike in the wage distribution at the minimum wage level is, in some contexts, a fiscal issue, more than a labour market issue, and therefore it would be incorrect to consider a high spike as an indication of a binding minimum wage. Also, differentiating the minimum wage along dimensions related to earnings (e.g. education, sector, or occupation) makes sense from an enforcement perspective.