Are Household Surveys Like Tax Forms: Evidence from Income Underreporting of the Self-Employed*

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 researcher 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. * We would like to thank the following for their helpful comments and discussions: Kerwin Charles, Raj Chetty, Steve Davis, Joshua Gottlieb, Larry Katz, Bruce Meyer, Matt Notowidingo, Michael Palumbo, Jesse Shapiro, and Bob Willis. We would also like to thank seminar participants at Boston College, Chicago, Harvard Business School, Penn State, Stanford, and the Federal Reserve Bank of Philadelphia. The views presented in this paper are those of the authors and do not represent those of the Federal Reserve Board or its staff. Hurst and Pugsley gratefully acknowledge the financial support provided by the George J. Stigler Center for the Study of Economy and the State. Additionally, Hurst thanks the financial support provided by the University of Chicago's Booth School of Business.