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Underground Economy

The underground economy encompasses any economic activity not reported to the government and, therefore, beyond the reach of tax collectors and regulators. The term may refer to either illegal activities or to ordinarily legal activities performed without the securing of required licenses and payment of taxes. Synonymous terms, especially when applied to these latter activities, are shadow economy and working off the books. Examples of legal activities in the underground economy include unreported income from self-employment, barter, do-it-yourself work, and neighbor help. Illegal activities include drug dealing, trade in stolen goods, smuggling, illegal gambling, fraud, and theft.

The size of the underground economy in the United States has been estimated to be $1 trillion in 2005. This represents about 9% of the total U.S. GDP. If taxes could be collected on these trillion dollars, the federal budget deficit would be wiped out. The underground economy is even larger than many other countries', accounting for up to 40% of economic activity in developing nations. Unreported economic activity tends to occur when excessive taxes, regulations, price controls, or state monopolies interfere with market exchanges. Failure to recognize or enforce private property rights and contractual agreements may also encourage underground economic activities.

Measurement of the underground economy is difficult because, by definition, its activities are not included in any government records. Its size may be extrapolated from sample surveys and tax audits or estimated from national accounting and labor force statistics. One of the most commonly used indicators is the demand for currency, especially bills of large denomination. Hundred-dollar bills, for example, are seldom used in legitimate business transactions. Increased demand for these bills indicates a rapid growth in the underground economy since 1970. Although the dollar has long been the currency of choice in the underground economy, the euro is gaining popularity.

Motivation of Participants

People work in the underground economy for a variety of reasons. Most people working off the books do so to supplement their mainstream jobs. The mainstream job provides benefits, such as health care and pensions, and the work off the books provides additional income. The mainstream job is needed also to provide a visible source of income if the worker should attract the attention of the authorities. This unreported moonlighting is especially prevalent in European countries, where holding a second job is often illegal. In the United States, working off the books is usually motivated by a desire to avoid income taxes. As income and social security taxes have increased because of the “bracket creep” effect of inflation, the incentive to avoid taxation has also increased.

Some workers in the underground economy have no mainstream jobs. Most of these are people who lack the skills, social networks, or documentation necessary to obtain jobs in the mainstream economy. The jobs held by these people, many of whom are undocumented immigrants, often pay less than minimum legal wage and fail to comply with government standards of health and safety. Some full-time underground economy workers with marketable technical skills choose this type of work because the jobs may pay more than mainstream jobs. A third category of workers prefers the underground economy jobs because of the personal freedom provided by temporary, irregular work.

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