Incentives for Undeclared Work

Prepared for Project on Undeclared Work in Hungary

Jan Svejnar

December 2007

Theoretical considerations

Informal (undeclared wage) sector Fallback (necessity)

Need policies for acquiring capabilities (or change regulation)

Simply enforcing taxes and regulations => fall in jobs and GDP, and increase in unemployment

Choice (optimization) Incentives to avoid paying taxes high when taxes and

benefits not tightly linked => distortions Distortions = labor supply to the taxpaying sector

becomes more limited, while in the informal sector employment goes up and productivity down => may lead to slower growth of GDP

Theoretical considerations (2)

If workers have incomplete information about or time-inconsistent view of social security (old age) benefits => less likely to work in formal sector => greater enforcement could increase welfare

Tax morale (inverse of tolerance of tax evasion) matters => expenditure accountability, governance, and public info. campaign = important issues

Watch out for unintended impacts (e.g., tiered tax system by size of business => disincentive to grow)

Empirical Approach

Using October 2007 TARKI survey of individuals we estimate the determinants of

% of wages the respondent thinks a typical company in his business declares for tax and social contributions

whether respondent or his employer pays for unemployment insurance

perceived effectiveness of reducing labor costs to employers as a measure to reduce undeclared work

Since individuals/firms vary in degree to which they view taxes as prepayment of benefits, explanatory variables are

characteristics of firms/jobs characteristics of workers

Empirical Estimates – Declared Wages Table 1 – OLS results on % of wages declared

Respondents in more formal parts of economy think firms declare less than do respondents in less formal parts

More formal = individual that has more other income qualifies for severance payments has trade union in his/her workplace has written work contract lives in central region of Hungary

Exception = having a permanent contract has a positive effect on the perception of how much firms declare

Respondents who have children (responsible, risk averse) think firms declare less than do respondents with no children

(2) (3)

Other Income -1.075* -1.021*

(0.548) (0.541)

Severance -11.166*** -11.979***

(3.563) (3.533)

Trade Union Presence -6.803** -7.124**

(3.369) (3.067)

Written Contract -37.742*** -37.759***

(9.198) (9.097)

Permanent Status 11.069** 10.265**

(5.202) (5.080)

With Children -6.371* -6.693**

(3.284) (3.362)

Manager/Employer 7.724 8.336

6.111 (5.938)

Central Region -4.093 -5.230

(3.824) (3.769)

Firm Size (Less than 5 employees) -2.181

(5.154)

Firm size (5-20 employees) 0.788

(3.767)

Constant 148.090*** 150.442***

(12.709) (12.332)

Observations 236 238

F 7.59 9.80

Adjusted R^2 0.219 0.229

Standard errors in parentheses. * p<0.1, **p<0.05, *** p<0.01

Table 1: Determinants of Percentage of Wage Payments Declared for Tax or Social Contributions

Estimates – Paying for Unemployment Insurance

Table 2 – only few systematic determinants of whether the respondent or his employer pay for unemployment insurance

= probability of paying unemployment insurance is not strongly related to observable characteristics of the individual and firm/job

Workers in construction are in firms that are less likely to pay for unemployment insurance

Workers with written contracts are in firms that are less likely to pay for unemployment insurance (?)

(2) (3)

Written Contract -2.133*** -2.108**

(0.857) (0.852)

Manager/Employer -0.847 -0.862

(0.537) (0.536)

Employer in Construction Sector -0.767 -0.732

(0.480) (0.478)

Trade Union Presence -0.444 -0.448

(0.341) (0.340)

Severance -0.344 -0.363

(0.341) (0.340)

Other Income -0.078 -0.078

(.058) (0.057)

With Children 0.295 0.299

(0.370) (0.328)

Central Region -0.400

(0.350)

Age (years) -0.004

(0.017)

Constant 5.050*** 4.781***

(1.18) (1.045)

Observations 278 278

Pseudo R^2 0.083 0.078

Standard errors in parentheses. * p<0.1, **p<0.05, *** p<0.01

Table 2: Determinants of Employer/Employee Contribution to Unemployment Insurance

Estimates – Reduction of Labor Costs to Employers

Table 3 – only few systematic determinants of whether the respondent views a reduction in costs for employers (minimum wage, severance, etc.) as an effective strategy for reducing undeclared work

= probability of respondent viewing a reduction in costs for employers is not strongly related to observable characteristics of the individual and firm/job

The probablilty of the strategy being viewed as effective is higher for those working in construction and in Central Hungary

(1) (2)

Other Income 0.082 0.865

(0.050) (0.050)

Severance 0.536* 0.552

(0.306) (0.298)

Trade Union Presence -0.393 -0.345

(0.277) (0.274)

Employer in Construction Sector 1.241* 1.020

(0.647) (0.569)

Manager/Employer 1.049 1.090

(0.661) (0.658)

Central Region 0.705** 0.589

(0.348) (0.338)

Written Contract 1.208

(1.103)

Permanent Status -0.515

(0.499)

Constant -0.473 0.201

(1.318) (0.537)

Observations 301 303

Pseudo R^2 0.060 0.048

Standard errors in parentheses. * p<0.1, **p<0.05, *** p<0.01

Table 3: Determinants of the Effectiveness of Reducing Labor Law Compliance Costs on Undeclared Work

Discussion

Survey – uneven evidence of undeclared wage sector Only about 2% of respondents report non-payment of

contributions for pensions or health insurance About 18% report non-payment of contributions for

unemployment insurance Few worker or firm/job characteristics affect

probability of unemployment insurance payment view that reducing labor costs to employers constitutes an

effective strategy for combating undeclared work Individuals in the formal sector think undeclared

wages are more of a problem than individuals in the less formal sector – Why (stereotype, truth telling)?