The Role of Cash in Illegal Labor Market Practices: Evidence from Uruguay

• In Event: Tax Enforcement and Wage Reporting

Abstract

This paper studies the effect of prohibiting the use of cash for wage disbursements on labor markets in developing countries. We study a reform in Uruguay that mandated wage payments to be disbursed using only electronic methods. Using a difference-in-differences approach based on sector-level cash intensity prior to the reform, our results indicate that firms in high cash intensity sectors are significantly more likely to discontinue formal activities post-reform. Active firms show a slight reduction in the number of employees and an increase in reported wages. These results are driven by low productivity firms. Complementary results using survey data indicate an increase in informal employment and a decrease in collusive underreporting of earnings partially explain these results. Overall, results suggest that, while eliminating cash for wage payments enhances tax compliance among formal workers, it may also shift some economic activity into full informality, offsetting the revenue gains from improved payroll tax compliance.

Authors

• Maximiliano Lauletta, maximiliano.lauletta@gmail.com

• Javier Feinmann, UC Berkeley

• Marcelo Bergolo, IECON-UDELAR