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.