Income underreporting by households with business income: evidence from Estonia

Abstract

This article estimates the extent of income underreporting by households with business income relative to households of wage earners in Estonia. It uses a modified version of the methodology pioneered by Pissarides and Weber. The extent of income underreporting is estimated by comparing food Engel curves for households with and without reported business income. The baseline result is that the reported total income of households with business income above 20% of total income must be multiplied by 2.6 in order to attain the same propensity to food consumption as households of wage earners. In this sense, households with business income underreport 62% of their ‘true’ total income. Households with reported business income above 0 but below 20% also underreport income but to a lesser extent. The estimates are higher than those found for developed countries but consistent with other studies of unreported activities in transition countries.