Chasing the Shadow: the Evaluation of Unreported Wage Payments in Latvia

We develop a novel way to evaluate the size of unreported wage payments at employee level. It is only the reported employer-employee income data combined with firm-level financial statements and survey information on various person-level indicators that are required for this purpose. We estimate the Mincer earning regression by the Stochastic Frontier Analysis approach, proxying the unreported wage payments by the non-negative inefficiency term. Our methodology is tested on the Latvian data: we find that small and young firms engage in illegal wage payments more than other firms. Unofficial payments to employees with small reported wages are more frequent and sizeable, revealing lower wage income inequality in Latvia when the unreported wage is taken into account.

Keywords: unreported wage, tax evasion, Mincer earning regression, income distribution
JEL Codes: E26, H26, J08, J31