During the past two or three years, the center of attention on the underground economy has gradually moved from the pages of newspapers into the pages of scholarly reviews. Reflecting this scholarly interest, several books have been published1 and conferences have been organized. The reason for studying the underground economy is self-evident because of the possible influence on economic policies of the distortion of official estimates of such macroeconomic variables as the national accounts, the employment rate, and the rate of inflation if the underground economy is large.2
There is still disagreement on the definition of the underground economy—and, perhaps even more, on its measurement—but progress is being made. As the present article is not intended to be a survey, it does not review that progress. Rather, using a method developed by the author a few years ago (and by now applied to a large number of countries), it presents yearly estimates for the underground economy in the United States for the period 1930–80.
Researchers have shown their resourcefulness by developing several alternative approaches to the measurement of the underground economy. Some have attempted a direct measurement of the various activities that make up this phenomenon (Internal Revenue Service (1979); Simon and Witte (1980)). Some have used questionnaires to elicit answers from persons interviewed as to whether they had participated in these activities either as buyers or as sellers (Isachsen, Klovland, and Strøm (1982); Hansson (1982)). Some have used employment statistics to attempt to estimate the number of those who were officially or unofficially unemployed, while they were actually working “underground” (Pettenati (1979); Contini (1982)). Others have attempted to estimate the underground economy from the differences between the consumption and the income side of the national accounts (Macafee (1980)); still others have utilized the information on income and consumption contained in household budget studies (Dilnot and Morris (1982)). Finally, there has been the monetary approach, of which the method used in this article is a variant.
Blades, Derek, “The Hidden Economy and the National Accounts,” OECD Economic Outlook: Occasional Studies (Paris, June 1982), pp. 28–45.
Burkett, Larry, and William Proctor, How to Prosper in the Underground Economy: A Completely Legal Guide to the Hidden, Multibillion-Dollar Cash Economy (New York, 1982).
Cagan, Phillip, The Demand for Currency Relative to Total Money Supply, National Bureau of Economic Research, Occasional Paper 62 (New York, 1958).
Clotfelter, Charles T., “Tax Evasion and Tax Rates: An Analysis of Individual Returns” (unpublished, 1982). (This article is scheduled for publication in Review of Economics and Statistics.)
Contini, Bruno, “The Second Economy of Italy,” Ch. 12 in The Underground Economy in the United States and Abroad, ed. by Vito Tanzi (Lexington, Massachusetts, 1982), pp. 199–208.
De Grazia, Raffaele, “Clandestine Employment: A Problem of Our Times,” International Labour Review, Vol. 119 (September/October 1980), pp. 549–63.
Dilnot, Andrew, and C.N. Morris, “What Do We Know About the Black Economy in the United Kingdom?” Ch. 10 in The Underground Economy in the United States and Abroad, ed. by Vito Tanzi (Lexington, Massachusetts, 1982), pp. 163–79.
Garcia, Gillian, and Simon Pak, “The Ratio of Currency to Demand Deposits in the United States,” Journal of Finance, Vol. 34 (June 1979), pp. 703–15.
Hansson, Ingemar, “The Underground Economy in a High Tax Country: The Case of Sweden,” Ch. 14 in The Underground Economy in the United States and Abroad, ed. by Vito Tanzi (Lexington, Massachusetts, 1982), pp. 233–43.
Internal Revenue Service, Estimates of Income Unreported on Individual Income Tax Returns, Publication No. 1104(9–79), U.S. Department of the Treasury (Washington, September 1979).
Isachsen, Arne Jon, Jan Tore Klovland, and Steinar Strøm, “The Hidden Economy in Norway,” Ch. 13 in The Underground Economy in the United States and Abroad, ed. by Vito Tanzi (Lexington, Massachusetts, 1982), pp. 209–31.
Klein, Lawrence R., and Richard F. Kosobud, “Some Econometrics of Growth: Great Ratios of Economics,” Quarterly Journal of Economics, Vol. 75 (May 1961), pp. 173–98.
Macafee, Kerrick, “A Glimpse of the Hidden Economy in the National Accounts,” Economic Trends, No. 316 (February 1980), pp. 81–87.
Molefsky, Barry, “America’s Underground Economy,” Ch. 3 in The Underground Economy in the United States and Abroad, ed. by Vito Tanzi (Lexington, Massachusetts, 1982), pp. 47–67.
Pettenati, Paolo, “Illegal and Unrecorded Employment in Italy,” Monte dei Paschi di Siena, Economic Notes, Vol. 8 (No. 1, 1979), pp. 14–30.
Simon, Carl P., and Ann D. Witte (1980), “The Underground Economy: Estimates of Size, Structure, and Trends,” in Government Regulation: Achieving Social and Economic Balance, Vol. 5, Special Study on Economic Change, Joint Economic Committee (96th Congress, 2nd Session, Washington, December 8, 1980), pp. 70–120.
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)| false ( Simon, Carl P., and Ann D. Witte 1980), “The Underground Economy: Estimates of Size, Structure, and Trends,”in Government Regulation: Achieving Social and Economic Balance, Vol. 5, Special Study on Economic Change, Joint Economic Committee( 96th Congress, 2nd Session, Washington, December 8, 1980), pp. 70– 120.
Smith, Adrian, “A Review of the Informal Economy in the European Community,” Commission of the European Communities, Economic Papers, No. 3 (Brussels, July 1981).
Tanzi, Vito (1979), “Underground Economy, Income Tax Evasion, and the Demand for Currency in the United States, 1929–76” (unpublished, International Monetary Fund, November 5, 1979).
Tanzi, Vito (1980 a), “Underground Economy Built on Illicit Pursuits Is Growing Concern of Economic Policymakers,” IMF Survey, Vol. 9 (February 4, 1980), pp. 34–37.
Tanzi, Vito (1980 b), “The Underground Economy in the United States: Estimates and Implications,” Banca Nazionale del Lavoro, Quarterly Review, No. 135 (December 1980), pp. 427–53.
Mr. Tanzi, Director of the Fiscal Affairs Department, holds a doctorate in economics from Harvard University. He was formerly a professor and Chairman of the Economics Department at American University.
International organizations have also started paying attention to the underground economy—obviously an important phenomenon. See, for example, De Grazia (1980), Tanzi (1980 a), Smith (1981), and Blades (1982).
In the actual calculations, the velocity of currency and of demand deposits are determined separately.
For a more detailed discussion of this point, see the author’s paper, “A Second (and More Skeptical) Look at the Underground Economy in the United States,” Ch. 6 in Tanzi (1982), pp. 103–18.
That method was first suggested and utilized in an unpublished paper (Tanzi (1979)); a substantially revised version was published in Tanzi (1980 b). Of related interest are also Cagan (1958) and Henry (1975). Henry’s paper was written while he was a graduate student at Harvard University; appreciation is due to him for bringing the paper to the author’s attention.
Obviously, some underground activities are not the result of taxes; therefore, estimates will not capture these activities. Convention, however, excludes the income generated from illegal activities from national accounts; it is likely that this income would vanish if it could be discovered and taxed. It should also be realized that the opportunity cost of the resources used for these activities is likely to be very low.
The equations have been corrected with a first-order Cochrane-Orcutt correction for serial correlation. The coefficients in parentheses are t-values. Two asterisks indicate significance at the 1 percent level; one asterisk indicates significance at the 5 percent level.
These estimates of tax evasion relate only to tax evasion that is associated with currency use and underground activities. But, obviously, many forms of tax evasion (claiming nonexistent exemptions, exaggerating deductions, nonreporting of interest income received, etc.) have nothing to do with currency usage or underground economic activities. Thus, these estimates do not measure total tax evasion.
For a recent paper on the relation between high marginal tax rates and tax evasion, see Clotfelter (1982).
For example, a drug smuggler who makes a large gain from his criminal activity would see his “income” dramatically reduced if (a) he were caught and jailed or forced to get a legal job, (b) if he gave up his activity because of improved law enforcement, or (c) if drug consumption were legalized. Therefore, these criminal incomes are totally arbitrary ones. In the author’s view, it makes no sense to include them in a definition of underground economy that emphasizes either potentially recoverable tax revenue or the use of resources for activities that should be measured by the national accounts.