How important is the American underground economy?

A reference to the underground economy – also known as the underground economy or the underground economy – may conjure up images of drug trafficking and prostitution rings, but the term actually has a much broader scope. It is any economic activity that is not declared to government authorities and, therefore, is not taxed.

Key points to remember

  • The underground economy includes any paid work or any transaction that is not reported to the government and therefore is not taxed.
  • During economic downturns, the underground economy thrives as more workers unable to secure legitimate jobs turn to work off the books.
  • Countries with high levels of taxation, government corruption, and regulatory barriers tend to have the largest underground economies.

Cooking a meal for your family or driving your neighbor’s children to school is generally not considered underground economic activity. But restaurant workers, housekeepers and construction workers who are paid illegally fall into this category, as do self-employed workers who work for money.

Basically, any economic activity that generates unreported income is considered underground.

How big is the underground economy?

Estimates vary widely, but some put the underground economy at 11% to 12% of the gross domestic product (GDP) of the United States. In 2018, the GDP was $ 20.8 trillion, bringing the underground economy to about $ 2.25 trillion to $ 2.46 trillion.

This number should be taken as an estimate. There is an obvious complication in trying to determine the size of a country’s underground economy. The activities it contains are by definition unreported, and those who engage in them do their best not to be detected.

Some indirect approaches have been used to estimate its size.

Counting money

One approach uses macroeconomic indicators as proxies to track underground economy activity over time. One of the most used is the demand for currencies. Most underground transactions use cash to avoid leaving a paper trail. Thus, this approach tracks gaps in demand for liquidity that could be attributed to underground economic activity.

Economist Friedrich Schneider valued that the size of the US underground economy, excluding criminal activities like drug trafficking, was 7.2% of gross domestic product (GDP) in 2007. This placed the US well below the world average for this year of 13.9% of GDP, according to the Organization for Economic Co-operation and Development.

11% to 12%

The estimated size of the US underground economy as a percentage of GDP in 2018.

At the time, Schneider saw that the underground economy was in decline, not only in the United States but around the world.

The rise and fall of the shadow economy

The 2008 global financial crisis, however, appears to have rejuvenated the underground economy.

Economist Edgar Feige estimated that underground economic activity in the United States in 2012 was $ 2 trillion, or about 12% of GDP.

Evidence of this can be found in a number of macroeconomic figures from the worst years of the Great Recession: a decline in the official U.S. workforce, an increase in the U.S. currency in circulation, and a curious increase in retail sales despite relatively high official unemployment. Numbers.

The wrong side

The pattern was easy to spot. As the economy slipped into recession, businesses downsized and consumers cut spending. Many people forced out of their jobs ended up working in the underground economy and hoping for better times to come.

One downside is the loss of government revenue. The IRS estimated that an average of $ 441 billion in taxes was lost between 2011-2013 due to unreported wages.

But there are other reasons to be concerned. The underground economy workers are really under the radar. They do not receive health insurance or workers’ compensation, and they have less legal protection. They do not contribute to their future social security benefits. It is much easier for these workers to be exploited.

Why we have an underground economy

If you haven’t guessed it already, one of the main reasons the underground economy exists is because people are trying to evade taxes. But there are other reasons.

Avoiding the government can also mean bypassing government regulations relating to benefits, working conditions, and safety regulations, not to mention much of the regulatory paperwork.

The undocumented factor

Immigrants without legal status often find themselves working for money in the underground economy. Obviously, their illegal status prevents them from declaring their income, as this could lead to their deportation.

An alternative for these undocumented immigrants is to buy false documents. In a 2018 article, The New York Times reported that these are readily available on the streets of Los Angeles, with a full package including a Social Security card and a green card ranging from $ 80 to $ 200. Papers can get them better jobs (and pay taxes on the wages they earn).

The level of government and local corruption is another factor that can contribute to a larger underground economy. The abuse of public power for private gain can push companies and workers to take refuge in the underground economy.

Shadows that shrink

All of the above makes the demise of the underground economy unlikely. But it is true that some countries have a much more serious problem than others.

This is precisely what a study by the International Monetary Fund (IMF) reveals. “Countries with relatively low tax rates, fewer laws and regulations, and a well-established rule of law tend to have smaller parallel economies,” the study concluded.

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Shawn G. Randall

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