# **1 Introduction**

In most countries, social security benefits depend on an individual’s earnings history. This contribution-benefit link creates a trade-off between the incentive to report higher earnings to increase the amount of future benefits (Fitzpatrick, 2017; French et al., 2022; Dean et al., 2024) and the incentive to report lower earnings to decrease the amount of taxes owed (Mortenson and Whitten, 2020; Bjørneby et al., 2021; B ́ır ́o et al., 2022). This trade-off is important for both the design of social security systems and approaches to combating tax evasion and encouraging formalization.

This paper studies the relationship between tax evasion and the contribution-benefit link in the context of maternity benefits among private sector workers in Hungary. We analyze reported earnings and employment before and after childbirth in an environment where the amount of maternity benefits received for two years after giving birth depends on earnings over a narrow time window before childbirth. Benefits are 70% of average earnings calculated over a reference period and are uncapped for six months and capped at 140% of the monthly minimum wage thereafter. In 2015, the incentive to report higher earnings became much stronger as the contribution period used to determine benefits changed from 12 months in the most recent calendar year to the first six months of pregnancy. Using detailed administrative data on employment, earnings, benefits, and health, we show that in response to these incentives, reported earnings and formal employment increase during pregnancy and that this response is much stronger after 2015.

Before 2015, the earnings of expectant mothers working in firms with fewer than 50 employees increased by 1.8% between the second and sixth months of pregnancy. This increase was much larger, 5.3%, after reporting incentives became stronger in 2015. In firms with fewer than 10 employees, the increase was even more pronounced, 3.0% before and 7.6% after 2015, while pre-birth earnings declined during pregnancy both before and after 2015 in firms with over 50 employees. Decreasing earnings in larger firms suggest that pregnancy negatively affects earnings, possibly due to health concerns, discrimination, or other factors. At the same time, increasing earnings in smaller firms suggest that another mechanism dominates in those firms: formalization of some previously informal earnings to obtain higher maternity benefits. That we detect this in smaller firms is in line with tax evasion being more likely and employer-employee coordination easier than in larger firms. Big increases in reported earnings are also more common in less-productive and domestic firms, also known to be more prone to tax evasion than more productive and foreign-owned firms (B ́ır ́o et al., 2022). Before large pre-birth earnings increases, earnings are concentrated at the monthly minimum wage (46% of women working in small firms earn either the minimum wage or the skilled minimum wage before pregnancy, decreasing to 2.5% during pregnancy). After large increases, they are concentrated at the benefitmaximizing threshold (27% of women working in small firms earn at the benefit-maximizing threshold, up from 3.3% before pregnancy) given the benefit cap, consistent with pre-pregnancy under-reporting and an adjustment just large enough to qualify for higher maternity benefits.

We also document an extensive-margin formalization response to maternity benefit incentives.

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