The Hidden Response to Minimum Wages: Wage Under-Reporting and Compliance in Mexico

• In Event: Boosting Wages: The Role of Public Policy

Abstract

This paper studies the interaction between minimum wage policy and wage under-reporting in settings with limited state capacity. In many developing countries, formal firms often evade payroll taxes by under-reporting the wages they pay to workers, offering part of their compensation “under the table” while reporting a lower amount to authorities. This practice distorts the interpretation of administrative data and undermines the goals of labor market regulation. We develop a simple theoretical framework that incorporates wage under-reporting into a standard monopsonistic labor market model. In this framework, firms optimally choose both the effective wage paid to workers and the wage they report to authorities. Under-reporting allows firms to reduce payroll tax obligations, but it comes at a cost of possible detection that increases with the discrepancy between actual and reported wages. A binding minimum wage imposes a constraint on reported wages, which may reduce the extent of under-reporting even if total compensation remains unchanged. This yields three key predictions: (i) larger firms evade less, consistent with enforcement frictions; (ii) reported wages increase more than effective wages following a minimum wage hike; and (iii) relying solely on administrative data may overstate the share of workers truly affected by the policy.

We test these predictions using Mexico’s 2019 minimum wage reform, which doubled the wage floor in the country’s northern border region. Combining rich administrative and survey data, we evaluate the impacts of the policy across several margins: formal employment, wage growth, worker mobility, andfirm dynamics. We find that the reform led to large increases in reported wages, but had surprisingly limited effects on formal employment, worker separations, or firm exit. The average wage and total reported wage bill rose in treated cities and firm exit remained flat, even among small establishments.

To assess whether these muted responses are consistent with increased reporting rather than real wage changes, we compare the distribution of reported wages in administrative records (IMSS) to those in household survey data (ENOE), which capture self-reported earnings. We find that the two distributions converge after the reform, particularly at the bottom of the distribution and only in treated cities. This suggests that employers responded to the higher wage floor by increasing the portion of wages they report, consistent with improved compliance rather than true increases in compensation.

Taken together, our findings suggest that in economies with weak enforcement, minimum wages can act as an enforcement tool, raising the share of wages reported to social security and strengthening both tax collection and benefit eligibility. These compliance effects operate through a different mechanism than standard employment responses and may help explain why minimum wage policies in low- and middle-income countries can show limited disemployment effects even after large wage shocks.

Author

• Jose Antonio Inguanzo Gonzalez, University of California - Los Angeles
  Presenting Author