Is it hurting U.S. economic strength?

Executive Summary

In the wake of the 2007-09 financial crisis, the underground sector has become a sizable part of the U.S. economy – perhaps as much as 10 percent. Many policymakers believe off-the-books work retards growth by denying tax revenues to governments, depressing wages, hurting competition and leaving workers vulnerable to abuse. Others argue that it’s a wash because a big share of any earnings go back into the economy as spending. They also see potential benefits: Workers gain flexibility and independence, and startups get breathing room. Currently, several states are cracking down on underground work as they face budget crunches. Economists, however, are divided over the potential impact of President Trump’s policies. Some say his tougher stance on illegal immigration will push more work underground, but others say his plans to reduce regulation and cut taxes could lead to a contraction of the informal economy.

Among the key takeaways:

  • Informal economies tend to be bigger in developing countries and to shrink as societies modernize.

  • Some economists see the underground sector as a nursery of future economic growth.

  • Unregulated or unlicensed work can give businesses that cut corners an unfair market advantage, penalizing employers and employees who play by the rules.

Resources for Further Study

Bibliography

Books

Rogoff, Kenneth S., “The Curse of Cash,” Princeton University Press, 2016. A Harvard economist suggests the best way to reduce the shadow economy – both legal and illegal – is by phasing out American currency.

Servon, Lisa, “The Unbanking of America: How the New Middle Class Survives,” Houghton Mifflin Harcourt, 2017. A University of Pennsylvania professor investigates why so many Americans no longer put their money in banks.

Venkatesh, Sudhir, “Floating City: A Rogue Sociologist Lost and Found in New York’s Underground Economy,” Penguin Books, 2014. A Columbia University sociologist explores the underground economy that connects the rich and poor in New York City.

Articles

Capps, Robert, “Why Black Market Entrepreneurs Matter to the World Economy,” Wired, Dec. 16, 2011, http://tinyurl.com/lx7fuoe. A journalist explains his research on the economic contributions of street vendors.

Rahn, Richard, “New Underground Economy,” The Washington Times, Dec. 9, 2009, http://tinyurl.com/kggbyd2. A Cato Institute economist argues that bad government policies are behind the rise of the underground economy.

Tucille, J.D., “Millions of Americans Who Avoid Banks Offer a Peek at the Underground Economy,” Reason, Sept. 15, 2015, http://tinyurl.com/mm99lsx. A journalist examines why many Americans are avoiding banks.

Zumbrun, Joshua, “More Americans Work in the Underground Economy,” Bloomberg, March 28, 2013, http://tinyurl.com/kotdor6. The rise of the underground economy after the 2007-09 recession is charted.

Reports and Studies

“Measuring the Unobserved Economy: A Handbook,” Organisation for Economic Co-operation and Development, 2002, http://tinyurl.com/mmca2nk. The OECD, International Monetary Fund and other national and international organizations provide a guide to measuring the underground economy in any nation.

Cebula, Richard, “The Underground Economy in the U.S.A.: Preliminary New Evidence on the Impact of Income Tax Rates (and Other Factors) on Aggregate Tax Evasion,” Jacksonville University, December 2014, http://tinyurl.com/k2jt58s. An economist finds some interesting factors, such as unpopular wars, affecting tax evasion.

Cooke, Oliver, et al., “The Underground Construction Economy in New Jersey,” William J. Hughes Center for Public Policy, June 2016, http://tinyurl.com/khx53mc. Stockton University economists investigate the extent of New Jersey’s underground construction economy and the effectiveness of enforcement.

Edwards, Ryan, and Francesc Ortega, “The Economic Impacts of Removing Unauthorized Immigrant Workers: An Industry and State-Level Analysis,” Center for American Progress, Sept. 21, 2016, http://tinyurl.com/l2neclz. Economists from the Center for American Progress, a liberal think tank, analyze how removing undocumented workers might affect the informal and formal economies.

Feige, Edgar L., and Richard Cebula, “America’s Underground Economy: Measuring the Size, Growth and Determinants of Income Tax Evasion in the U.S.,” Crime, Law and Social Change, Vol. 57 Issue 3, April 2012, http://tinyurl.com/k4g4h2g. Two economists attempt to measure the underground economy.

Holtzblatt, Janet, and Jamie McGuire, “Factors Affecting Revenue Estimates of Tax Compliance Proposals,” Joint Working Paper of the Congressional Budget Office and the Staff of the Joint Committee on Taxation, November 2016, http://tinyurl.com/lxz3vas. Two congressional analysts examine the potential impact of tax compliance enforcement proposals and find that some of them wouldn’t help reduce the budget deficit.

Nava, Pedro, et al., “Level the Playing Field: Put California’s Underground Economy Out of Business,” The Little Hoover Commission, March 2015, http://tinyurl.com/nav6hq5. An independent oversight agency takes on California’s underground economy and offers recommendations on improving enforcement to decrease cheating.

Nightingale, Demetra Smith, and Stephen A. Wandner, “Informal and Nonstandard Employment in the United States: Implications for Low-Income Working Families,” The Urban Institute, August 2011, http://tinyurl.com/mjajfl5. Economists look at the underground economy and explore ways to be more supportive of low-income families.

Singh, Anoop, Sonali Jain-Chandra and Adil Mohommad, “Inclusive Growth, Institutions and the Underground Economy,” International Monetary Fund Working Paper, February 2012, http://tinyurl.com/l6nn7cj. International Monetary Fund economists explore the role of entrepreneurs in the underground economy.

Weber, Till Olaf, Jonas Fooken and Benedict Hermann, “Behavioral Economics and Taxation,” European Commission Taxation Working Papers, 2014, http://tinyurl.com/kxrpl2g. A group of European economists look at the reasons why people evade taxes.

The Next Step

International Activity

“Underground economy accounts for 8% of GDP in 2015,” Korea Herald, Feb. 17, 2017, http://tinyurl.com/k425dv4. About 8 percent of South Korea’s gross domestic product (GDP) in 2015 came from the $109 billion underground economy, the Korea Institute of Public Finance said in its latest report.

Koehn, Emma, “More than 400 SMEs to receive visits from the ATO as it ramps up focus on Australia’s cash economy,” SmartCompany, March 7, 2017, http://tinyurl.com/kee63ca. The Australian government continues its crackdown on small businesses operating in the “black economy,” which is about 2 percent of that nation’s GDP.

Salzano, Giovanni, and Lorenzo Totaro, “Italy Debt Tops 150% of GDP Without Underground, Illegal Economy,” Bloomberg, Oct. 14, 2016, http://tinyurl.com/kvp933k. Without the underground economy’s contribution to national wealth, the ratio of Italy’s public debt to gross domestic product would jump from 132.8 percent to 152.6 percent, according to new data.

Digital Push

Dwivedi, Yogesh K., et al., “Demonetization could spark a new digital economy in India,” Quartz, Nov. 22, 2016, http://tinyurl.com/kk6lw84. Indian Prime Minister Narendra Modi withdrew from circulation the country’s two highest cash notes in an attempt to suppress illicit activities and the underground economy, which deals mainly in cash transactions.

Verbyany, Volodymyr, “Ukraine Wants to Go Cashless But the Black Market Rules,” Bloomberg, Feb. 15, 2017, http://tinyurl.com/l7et422. Ukraine’s central bank outlawed cash transactions of more than $1,850 and encouraged electronic payments in an effort to shrink the nation’s underground economy.

Weller, Chris, “America has the technology to go cashless, but nobody trusts it enough to use it,” Business Insider, Nov. 17, 2016, http://tinyurl.com/m27cfg5. Unlike Sweden, where only 2 percent of transactions are conducted with cash and a digital currency is a possibility, the United States continues to use cash due in part to Americans’ distrust of the government and fears about online privacy.

Organizations

Federal Deposit Insurance Corp.
550 17th St., N.W., Washington, DC 20429
877-275-3342
www.fdic.gov
Federal agency that keeps statistics on the percentage of people who don’t use banks and are more likely to be in the underground economy.

Internal Revenue Service
1111 Constitution Ave., N.W., Washington, DC 20224
202-622-5000
www.irs.gov/uac/compliance-enforcement
The nation’s tax collection agency.

International Monetary Fund
700 19th St., N.W., Washington, DC 20431
202-623-7000
www.imf.org
This international organization is a good source of research on economies large and small.

Little Hoover Commission
925 L St., Suite 805, Sacramento, CA 95814
916-445-2125
http://www.lhc.ca.gov/
littlehoover@lhc.ca.gov
California’s independent state government oversight agency does research on the underground economy.

Organisation for Economic Co-operation and Development
1776 I St., N.W., Suite 450, Washington, DC 20006
202-785-6323
www.oecd.org/Washington
International organization that works to promote economic policies and to alleviate poverty. Also created a handbook to help economists measure underground economies.

DOI: 10.1177/237455680310.n1