Tax Evasion and Self-Employment in a High-Tax Country: Evidence from Sweden

Transcription

1 Tax Evaion and Self-Employment in a High-Tax Country: Evidence from Sweden by Per Engtröm * and Bertil Holmlund ** Thi verion: May 17, 2006 Abtract Self-employed individual have arguably greater opportunitie than wage earner to underreport their income. The incentive for underreporting hould be epecially trong in an economy with generally high taxe. Thi paper ue recent income and expenditure data to examine the extent of underreporting of income among elf-employed individual in Sweden. A key hypothei i that underreporting of income among the elf-employed would be viible in the data a exce food conumption, for a given level of oberved income. Our reult confirm the underreporting hypothei. In particular, we etimate that houehold with at leat one elf-employed member underreport their total income by around 30 percent. Underreporting appear to be twice a prevalent among elf-employed people with unincorporated buinee a among thoe with incorporated buinee. Keyword: Tax evaion, elf-employment, Engel curve. JEL-code: D12, H24, H25, H26. Financial upport from the Swedih National Tax Board (Skatteverket) i gratefully acknowledged. We thank Annika Peron and other eminar participant at Skatteverket for ueful comment. We alo thank Åa Anderon and Katarina Hanon at Statitic Sweden for helpful guidance regarding the data. * Department of Economic, Uppala Univerity, Box 513, SE Sweden. per.engtrom@nek.uu.e ** Department of Economic, Uppala Univerity, Box 513, SE Sweden. bertil.holmlund@nek.uu.e

2 1 1. Introduction It i widely believed that elf-employed people can more eaily underreport their taxable income than wage earner are able to do. Several reearcher have tried to etimate the extent of underreporting by uing information on conumption expenditure and reported income. The key idea i that expenditure on food i accurately reported by all people participating in an expenditure urvey, or at leat that there i no ytematic mireporting that i related to employment tatu. If the elf-employed underreport their income, thi would be viible in the data a exce food conumption among elf-employed people, for a given level of oberved income. If one can get an etimate of the extent of underreporting, it i alo poible to get an etimate of the ize of the black economy relative to GDP that i related to elfemployment activitie. The expenditure-baed approach to etimation of tax evaion and the ize of the black economy wa pioneered by Piaride and Weber (1989) and ha been applied in a number of other tudie. Piaride and Weber examined Britih data from 1982; Apel (1994) provided evidence for Sweden uing data from 1988; Johanon (2000) ued Finnih data from the mid- 1990; Schuetze (2002) examined conumption and income in Canada over the period ; Lyiotou et al (2004) invetigated conumption and income uing Britih data from The tudie by Apel, Johanon and Schuetze follow the Piaride and Weber approach cloely, wherea Lyiotou et al develop a omewhat different methodology baed on conumer demand ytem. An alternative nonparametric methodology i developed by Tedd (2004). The available empirical tudie generally upport the baic hypothei: elf-employed people do tend to underreport their income relative to wage earner. There i, however, coniderable diperion in the etimate of underreporting. Piaride and Weber (1989) etimate the mean underreporting to around 55 percent, wherea Apel (1994) report a mid-point etimate of around 35 percent. Schuetze (2002) report underreporting in the interval 11 to 23 percent, wherea Johanon (2000) etimate underreporting by ome 27 percent on average. Lyiotou et al (2004) etimate that true income for blue collar elf-employed people i more than 100 percent greater than reported income, wherea true income for white-collar elfemployed people exceed reported income by 64 percent. The implication of thee variou etimate on the relative ize of the black economy depend to the relative importance of elfemployment in the economy. Piaride and Weber conclude that black economy activitie

3 2 related to elf-employment amount to 5 percent of GDP in the United Kingdom; Apel get an etimate for Sweden of only 1 percent, wherea Johanon get 2 percent for Finland. The etimate in Lyiotou et al imply that cloe to 11 percent of the UK economy involve black economy activitie related to elf-employment. The diperion in etimate i thu coniderable, and the reaon for the different etimate are not well undertood. Thi paper take a new look at conumption expenditure and reported income among elfemployed people and wage earner in Sweden. Sweden ha the highet tax-to-gdp ratio in the world, and there i a preumption that the incentive for tax evaion would be particularly pertinent in uch an economy. 1 We ue two ample, the firt for the year and the econd for Our reult confirm the underreporting hypothei. Specifically, we etimate that the degree of income underreporting hover around 30 percent of houehold income for a houehold with at leat one elf-employed member. We alo examine whether the degree of underreporting varie by the legal form of elfemployment and find triking difference between incorporated and unincorporated buinee: elf-employed in the latter category are much more prone to underreporting than thoe in the incorporated category. We interpret thee difference a the outcome of difference in regulation that entail higher cot of tax evaion aociated with incorporated buine activitie. Thee reult baed on expenditure pattern are conitent with oberved earning difference between paid employee and elf-employed individual. Controlling for human capital characteritic and indutry affiliation, we find that elf-employed individual with unincorporated buinee report ubtantially lower income than employee a well a lower income than elf-employed in the incorporated category. The next ection dicue briefly the Piaride and Weber methodology. Section 3 of the paper preent the data, ection 4 give the reult and ection 5 conclude. 2. Etimating Tax Evaion from Expenditure Data The Piaride and Weber approach can be illutrated by mean Figure 1. Let c denote log food conumption, c= ln C F, and y log dipoable income, y = lny D. The figure how two 1 According to OECD data, the tax-to-gdp ratio in Sweden tood at 50.7 percent in 2004 which i the highet ratio among OECD countrie; Denmark came econd at 49.6 percent. Agell et al (1996) provide an overview and evaluation of the major 1991 reform of the Swedih tax ytem. Sandmo (2005) preent a recent urvey of the theory of tax evaion.

4 3 log-linear conumption-income profile (Engel curve), one for elf-employed people (SE) and one for wage earner (WE). By aumption, the elaticity of conumption with repect to income i equal for the two group; the Engel curve have thu the ame lope. However, we allow the intercept to differ o a to capture the poibility of underreporting of income among elf-employed people. Imagine two individual, one elf-employed and one wage earner, who both report conumption level c *. The wage earner report income level wherea the elf-employed peron report income w y y. Suppoe that conumption i truthfully reported by both type and that income correpond to true income for the wage earner but not for the elf-employed peron. If preference are the ame, we can infer that the elf-employed peron true income i w y rather than reported y. The extent of underreporting i thu given by y w y. Figure 1. Engel curve for wage earner (WE) and elf-employed people (SE) c SE WE c * y w y y Now uppoe that we pool the data for elf-employed people and wage earner and etimate an equation of the form: (1) ci = Xiα + βyi + γsei + εi where ubcript i denote individual i, X i a vector of variable affecting conumption (in addition to income), SE i a dummy variable for elf-employed peron and ε i a random

5 4 error term. The parameter γ capture the vertical ditance between the two Engel curve; γ > 0 implie ome underreporting of income among elf-employed people. The degree of w underreporting (in log) i obtained a y y = γ / β. For example, if γ =.05 and β = 0.5, we get γ / β = 0.10, which ay that elf-employed people underreport their income by around 10 percent. The percentage difference i generally obtained a [ ] D 100 exp( γ / β) 1. We might alternatively expre underreporting in term of k exp( γ / β ), which give the number by which a elf-employed peron dipoable income ha to be multiplied o a to get the true dipoable income. With γ =.05 and β = 0.5, we get k= The etimate of underreporting obtained from eq. (1) pertain to dipoable income. We might alternatively expre underreporting in term of gro income. Let * Y denote true gro * * income, U the amount of underreported income and define κ Y /( Y U) a the ratio between true and reported gro income. It follow that κ = k(1 t) + t, where t i the effective tax rate. 2 Clearly, we haveκ < k. Etimation of (1) raie everal iue that are dicued in Piaride and Weber (1989) and ome of the ubequent literature. One iue i how income hould be interpreted and treated in the etimation. The mot relevant income concept i arguably permanent income rather than current income. However, exiting data et include only data on current income. Piaride and Weber, a well a much of the ubequent literature, have attempted to reolve thi problem by treating current income a endogenou and purued intrumental variable etimation. A potential problem with thi approach i that it relie on perhap arbitrary excluion retriction for identification: one need to find variable that affect dipoable income without directly affecting alo food conumption. We will preent reult from OLS a well a from IV etimation; in fact, the reult are very imilar. 2 By effective tax rate we mean t=1 - (dipoable income/total factor income). Tranfer to houehold add to D dipoable income and thu reduce the effective (average) tax rate. Reported dipoable income, Y, i given a D * * * * Y = Y t( Y U). We have κ Y /( Y U) and k i the ratio between true dipoable income and reported dipoable income. We thu get κ = k(1 t) + t.

6 5 3. The Data We have ued data from the Swedih Houehold Budget Survey (Huhållen utgifter, HUT) from , 2003 and Data for are baed on urvey to houehold that include the econd quarter of 1999 up to the firt quarter of Around 9000 randomly elected houehold were approached over thee year, but only lightly above 50 percent of thoe did actually participate in the urvey. In 2003 and 2004, 4000 houehold were approached each year and the repone rate wa 58 percent both year. The repone rate are thu fairly low, although not exceptionally low for thee kind of time intenive urvey. The urvey are produced and preented by Statitic Sweden a one urvey and we will refer to it a HUT The other two urvey are produced and preented by Statitic Sweden a two eparate urvey. We will concatenate the urvey for 2003 and 2004 and refer to the reulting linked data et a HUT The HUT data contain no panel element. The participating houehold were aked to report their conumption expenditure during randomly elected two-week period. In addition, upplementary quetion were aked regarding expenditure over the pat 12 month. Variou other quetion were aked o a to get information on houehold characteritic, including employment tatu and occupation. Information about dipoable income i obtained from official income and tax regiter and merged with the expenditure data. The two key variable are annual food conumption and annual dipoable income. We follow the literature by focuing on food conumption on the aumption that thi i truthfully reported and that expenditure function for food are imilar for employee and elf-employed people. Our meaure of food conumption i reported in the data a food purchae. 4 Dipoable income i baed on all type of (regiter-baed) income, including tranfer. Taxe are deducted from gro income o a to get houehold dipoable income. We focu on conumption and income among employee and elf-employed people. Selfemployment tatu can be defined in everal way. Mot previou tudie in thi genre have 3 The deign and main reult of the HUT-tudie are preented in report from Statitic Sweden (2003, 2004, 2005). 4 We have obtained imilar reult for broader meaure of food conumption, uch a food purchae plu meal out.

7 6 claified houehold by uing information on income hare attributed to paid employment and elf-employment. 5 A problem with thi approach, beide the difficulty of chooing the borderline, i that it may be enitive to the legal form of the buine. A peron who run an incorporated buine may be formally employed by the company and receive the main part of the compenation in the form of wage income. We prefer to make ue of elf-reported information on employment tatu of the individual houehold member. A a requirement for ample incluion we require either that (i) at leat one member of the houehold i employed or elf-employed, or that (ii) two member are employed or elf-employed. The elf-employed category include incorporated a well a unincorporated buinee and the data contain information about the legal form. We have excluded farmer, however, auming that their food purchae exhibit a pattern relative to income that differ from other elf-employed people. Following Piaride and Weber (1989) and other in the literature, we alo retrict the analyi to houehold with married or cohabiting couple. The bigger ample, fulfilling criterion (i), comprie around 3000 houehold for a well a for The maller ample (ii) include a little more than 2000 houehold for a well a for The hare of elfemployed varie between 13 and 16 percent according to the adopted definition. 6 A firt look at the data i given in Table 1. The table diplay average food conumption and dipoable income among employee and elf-employed in our ample. A houehold i here claified a elf-employed if at leat one member i elf-employed. Average income are lightly higher among employee, wherea food conumption i higher among the elf-employed. It i thu clear that food conumption relative to income i higher, on average, among elf-employed people. The difference amount to around 4 percentage point. 7 Thi pattern i what we would expect according to the hypothei that elf-employed people are more likely to underreport their true income. Of 5 Piaride and Weber (1989) define houehold a elf-employed if income from elf-employment account for at leat 25 percent of total income. 6 The fraction of elf-employed in total employment i 10 percent according to the labor force urvey of Note that our ample i retricted to couple. Moreover, our meaure of the rate of elf-employment in houehold i not directly compared to the labor force urvey data baed on individual. 7 The food conumption ratio are ubtantially lower in than in the previou urvey, a pattern alo viible in the aggregate data publihed by Statitic Sweden. The likely main reaon for the difference i that the meaurement technique have changed. According to Statitic Sweden (2003), the urvey for produced an upward bia in food conumption by inducing houehold to include ome non-food item in their report of food purchae.

8 7 coure, thi i jut a firt look at the data and we need to control for other variable that may affect conumption. Thi i the topic for the next ection. Table 1. Mean of variable Houehold with at leat one member employed or elfemployed Houehold with at leat two member employed or elfemployed Houehold with at leat one member employed or elfemployed Houehold with at leat two member employed or elfemployed Employee Employee Employee Employee Selfemployed Selfemployed Selfemployed Selfemployed lny D F ln C F D C / Y # ob D F Note: Dipoable income ( Y ) and food conumption ( C ) i in unit of SEK, 2001 price for and current price for A houehold i claified a elf-employed if at leat one member i elf-employed. A few houehold with income above two million SEK are excluded. 4. Etimation Reult We have etimated a number of model along the line of eq. (1). That i, we regre log food conumption on log dipoable income and a bunch of control variable. The latter include age and age quared, type of houing, number of children under age 20, average year of education among adult houehold member, and region of reidence. 8 We ue two alternative definition of elf-employment tatu. One variable (SE_1), with aociated parameterγ 1, i a dummy for houehold where at leat one member i elf-employed. The econd variable 8 Age i the age of the houehold head, which i the peron with the highet income in the houehold; type of houing i a dummy for ingle family houing; region are o called H-region, which capture the degree of urbanization.

9 8 (SETOT), with aociated parameter γ 2, i the number of peron who are elf-employed in the houehold; thi variable take only three value in our ample, viz. 0, 1 or 2. Preliminary analye revealed very imilar reult for the ample and the ample. We have therefore decided to concatenate all data, thu obtaining a data et compriing five year. The etimation reult for the baic pecification are et out in Table 2. Table 2. Etimation reult for the pooled data. Dependent variable: ln C F Houehold with at leat one member employed or elf-employed Houehold with at leat two member employed or elf-employed OLS (1) OLS (2) IV (3) IV (4) OLS (5) OLS (6) IV (7) IV (8) lny D ( β ).233 (10.75).234 (10.87).259 (3.52).258 (4.44).219 (8.36).222 (8.48).185 (2.26).184 (2.59) SE_1 ( γ 1).065 (3.55).070 (3.53).056 (2.92).054 (2.60) SETOT ( γ ) (3.98).069 (4.35).055 (3.32).054 (3.14) k exp( γ j / β ) R # ob Note: SE_1: at leat one elf-employed; SETOT: number of elf-employed {0,1, 2}. The other control are age, age quared, number of children, ingle family houe, average year of chooling in the houehold, ix dummie for H-region and a dummy for The intrument ued in the IV etimation are income from capital and property taxe. Houehold with income above 2 million SEK are excluded. Robut tandard error, abolute t-value in parenthee.

10 9 In the IV etimation we ue two variable to achieve identification, viz. income from capital and property taxe. Property taxe are cloely related to the market value of owned houing (including houing ued for recreational purpoe). A comparion acro column how that the coefficient pertaining to elf-employment tatu are fairly robut a well a tatitically ignificant at conventional level. The interpretation i that elf-employed houehold are characterized by exce food conumption by 5 to 7 percent. That i, they pend 5 to 7 percent more on food relative to wage earner with the ame reported income. The extent of underreporting, a meaured by k exp( γ / β ), varie in a fairly narrow band around That i, the degree of underreporting amount to 30 percent. Our etimate of underreporting are in the ame (big) ballpark a thoe reported in mot previou tudie (with the exception of Lyiotou et al, 2004). j Thee etimate of underreporting are expreed in term of dipoable income. Uing the fact that the ratio between true and reported gro income i given by κ = k(1 t) + t, we obtain κ 1.23 in our data. Effective tax rate are fairly low in our ample, reflecting the fact that taxe to a ubtantial degree are ued to finance tranfer to houehold. Self-employment tatu according to our definition doe not exactly correpond to the hare of houehold income that can be attributed to elf-employment. Recall that k=1.30 mean that houehold with elf-employed member underreport their dipoable income by 30 percent. However, elf-employed houehold typically include alo employee with wage income o 30 percent i not an etimate of how much underreporting of elf-employment income there i. To arrive at uch an etimate, we define elf-employment income a including (i) entrepreneurial income 9 and (ii) wage income for houehold with incorporated buinee (on the aumption that owner of incorporated buinee are employed by their companie). Let μ denote the ratio between thi (adjuted) meaure of reported gro income from elfemployment and total reported gro income among elf-employed houehold. Underreporting of income from elf-employment can be derived a (2) D U κ 1 = = U + Y μ+ κ 1 9 In Swedih, thi concept i known a inkomt av näringverkamhet.

11 10 where Y i reported income from elf-employment in elf-employment houehold (auming that underreporting i only relevant for elf-employment income). In our data for , we have μ 0.43 o we obtain D 0.35 uing κ = Thu, we can conclude that houehold with at leat one elf-employed member underreport their income from elf-employment by roughly 35 percent. Note that thi i a conervative etimate ince μ i an upper bound of elf-employment income relative to total income. Heterogeneou Effect Among the elf-employed in our ample, around 50 percent run an incorporated buine. Thoe with incorporated buinee are preumably employed by their company and paid by the company. Indeed, our data reveal that wage income account for a much higher hare of gro income among elf-employed houehold with incorporated buinee than among thoe with unincorporated buinee. Incorporated buinee are circumcribed by other and more elaborate legal rule than thoe relevant for unincorporated buine activitie. The tranaction pertaining to the corporation and thoe pertaining to the owner hould be kept apart. An annual financial report, which become public information, hould be delivered for each financial year. Moreover, a certified auditor mut be appointed and the auditor report on the financial tranaction of the company i public information. For unincorporated buinee, on the other hand, the borderline between the owner and the company financial tranaction i fuzzy and the tranaction are le eaily crutinized by outider. Thee difference in the legal form of elf-employment are likely to influence incentive for tax evaion. There i a preumption that the more tringent legilation pertaining to incorporated buinee mean higher cot of tax evaion. We have examined whether the legal form of elf-employment matter by including variable for incorporated and unincorporated buinee, repectively. The definition are analogou to thoe already defined. For example, SE_1 (inc.) take the value of one when at leat one houehold member run an incorporated buine. The reult are given in Table It i more difficult to dientangle income ource in the data o we focu on

12 11 Table 3. Underreporting by the legal form of elf-employment. Dependent variable: ln C F. Houehold with at leat one member employed or elf-employed Houehold with at leat two member employed or elf-employed OLS (1) OLS (2) IV (3) IV (4) OLS (5) OLS (6) IV (7) IV (8) lny D.237 (10.92).237 (10.97).269 (.075).268 (3.56).224 (8.56).225 (8.61).195 (2.33).194 (2.32) SE_1 (inc.).039 (1.58).040 (1.62).028 (1.09).030 (1.16) SE_1 (uninc.).089 (3.47).098 (3.37).084 (3.12).079 (2.55) SETOT (inc.).041 (1.92).042 (1.96).031 (1.40).032 (1.45) SETOT (uninc.).086 (3.76).095 (3.65).080 (3.40).078 (2.82) k exp( γ j / β ) (inc.) k exp( γ j / β ) (uninc.) R # ob Note: SE_1: at leat one elf-employed (incorporated, unincorporated); SETOT: number of elf-employeed (incorporated, unincorporated). The control are age, age quared, number of children, ingle family houe, average year of chooling in the houehold, ix dummie for H-region and a dummy for The intrument ued in the IV etimation are income from capital and property taxe. Houehold with income above 2 million SEK are excluded. Robut tandard error, abolute t-value in parenthee. There i a clear pattern in the reult uggeting that elf-employment aociated with incorporated buinee involve le tax evaion than elf-employment in general. Selfemployed with incorporated buinee underreport ome 15 to 20 percent of their income, although thee etimate are typically only marginally ignificant. Self-employed with

13 12 unincorporated buinee underreport at the rate of 40 to 50 percent. Thee reult are conitent with the hypothei that incorporated buinee face higher cot of tax evaion a a reult of more detailed regulation. We can alo in thi cae ak how large proportion of elf-employment income that i hidden from the authoritie. Among houehold with unincorporated buinee, entrepreneurial income account on average for roughly 40 percent of total houehold income. To get an etimate of the amount of hidden entrepreneurial income, we ue (2) and arrive at D That i, elf-employed houehold with unincorporated buinee hide around 50 percent of their true income. We have alo checked for heterogeneou age effect by including interaction between the elf-employment variable and a dummy for houehold head over the median age (which i 44 in the data). However, we did not find any evidence that the propenity to underreport varie by age. Analogouly, we have checked whether the effect varie by gender by interacting elf-employment tatu and a gender dummy (equal to one if the elf-employed peron i a woman). We found no tatitical ignificance for thi interaction variable. We alo checked whether killed blue collar worker are more prone to tax evaion relative to other employee, a hypothei motivated by anecdotal evidence a well a ome previou empirical finding (ee Piaride and Weber, 1989, and Peron, 2006). However, we could not find any ytematic evidence upporting thi hypothei. Corroborating Evidence: Income and Employment Statu An arguably traightforward approach to examine tax evaion by employment tatu would be to look at difference in reported income between employee and elf-employed individual with imilar meaurable human capital and other characteritic. That i, we could etimate model of the form (3) ln Y i = Z i δ + σse i + η i where Y i gro income, i.e., income before taxe and tranfer. Z i a vector of peronal characteritic and SE a dummy for (individual) elf-employment tatu. A negative ign of

14 13 σ would be conitent with underreporting of income among the elf-employed. 12 Of coure, a negative etimate could alo reflect compenating income difference, which could be preent to the extent that individual place a poitive value of elf-employment tatu becaue it may confer non-pecuniary benefit uch a peronal independence ( being your own bo etcetera). 13 On the other hand, the elf-employed are known to work longer hour than the typical employee, a fact that would contribute to higher annual earning. 14 We have etimated a number of equation of the type given by (3) on data for 2004, focuing a before on married (or cohabiting) individual aged 20 to 64. The pecification include, inter alia, ome 50 indutry dummie a well a ix regional dummie. The reult are diplayed in Table 4. The etimate in the firt three column are baed on a narrow income concept, wherea the lat three column are baed on a broad concept that include all income from labor and capital. The etimate imply that elf-employed individual earn ubtantially lower income than wage earner. For given characteritic, the level of (reported) income i around percent lower among the elf-employed individual with unincorporated buinee. 18 For individual with incorporated buinee, the negative effect i maller (in abolute value) and at bet only marginally ignificant The pattern et out in Table 4 are conitent with what we found in the analyi of conumption behavior, i.e., trong evidence of underreporting for houehold with unincorporated buinee but only weak evidence for houehold with incorporated buinee. The reult in Table 4 might, however, reflect compenating income difference aociated with employment tatu a well a underreporting of income. Although thi eem likely, it i not clear why the legal form of a buine ownerhip hould matter much for job atifaction. 12 Peron (2005) compare earning among employee and elf-employed uing Swedih data for 2002 and find ubtantially lower reported earning among the elf-employed even after having tandardized for indutry affiliation. The paper doe not ditinguih between incorporated and unincorporated buinee, however. 13 See Hamilton (2000) for a tudy of the return to elf-employment in the United State. Hamilton find a ubtantial earning penalty aociated with elf-employment, a reult that he interpret a evidence of nonpecuniary elf-employment benefit. Blanchflower (2004) urvey the literature on elf-employment and report that job atifaction i higher among elf-employed than among wage earner. 14 According to the Swedih labor force urvey for 2004, paid employee worked on average 35 hour per week wherea elf-employed people worked 43 hour. 18 The etimate in column (1) imply exp(.701) 1 0.5, wherea the etimate in column (4) imply exp(.500)

15 14 Table 4. Income and elf-employment tatu Dependent variable: lny. Y: wage plu entrepreneurial income Y: total factor income Both exe (1) Men (2) Women (3) Both exe (4) Men (5) Women (6) Age.118 (8.63).092 (5.58).142 (6.31).115 (8.63).096 (5.51).129 (6.30) Age quared/ (7.73) (5.08) (5.56) (7.69) (4.95) (5.55) Education (yr).066 (9.93).077 (8.81).056 (5.47).069 (10.54).077 (8.45).063 (6.38) Female (13.13) (3.10) # children (2.92).008 (.045) (3.05) (3.10) (.92) (2.86) SE uninc (3.51) (2.92) (2.01) (2.97) (2.26) (1.93) SE inc (1.79) (1.64) (.94) (.55) (.45) (.55) 2 R # ob Note: All pecification include region dummie a well a a full et of (feaible) indutry dummie (maximum 52). Total factor income include in addition to wage and entrepreneurial income dividend, interet payment and capital gain. Robut tandard error, abolute t-value in the parenthee. 5. Concluding Remark Our tudy of food expenditure and income among employee and elf-employed ha produced reult that are broadly conitent with finding from previou tudie. There i trong evidence of exce food conumption among the elf-employed, for a given level of dipoable income. A plauible interpretation i that the pattern reflect underreporting of

16 15 income among the elf-employed. The magnitude of underreporting i non-trivial: our etimate ugget that the houehold with at leat one member underreport their total income at the average rate of 30 percent and their income from elf-employment by around 35 percent. Our reult alo imply that tax evaion i mot pronounced among elf-employed who run unincorporated buinee. We interpret thi finding a indicating higher cot of tax evaion for owner of incorporated buinee ince their tranaction are more eaily expoed to public crutiny. Our look at income differential between employee and elf-employed offer reult conitent with the analyi of conumption data. Reported income among the elf-employed, and in particular thoe with unincorporated buinee, are ubtantially lower than income among employee even after controlling for human capital characteritic and indutry affiliation at a fairly detailed level. Although thi pattern could reflect many different force, including compenating earning difference, it eem likely that tax evaion behavior i part of the tory. In fact, longer work hour would tend to create an earning advantage (rather than a penalty) for the elf-employed. There i no obviou policy precription that follow from our reult. However, the fact that tax evaion eem to depend on the legal form of elf-employment i of potential policy relevance. The regulatory framework pertaining to mall firm i ubject to ongoing policy dicuion, often emphaizing the need to implify the regulation o a to facilitate entrepreneurhip. One iue concern whether independent auditing hould be required for all incorporated buinee, including (very) mall firm. The detail of the regulatory framework matter for incentive for tax evaion, a conideration that need to be acknowledged in the policy dicuion.

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