The Huge Underground Economy

Illegal Activities, Cash Transactions Really Add Up

The Huge Underground Economy
July 30, 2014

When you hear statistics about the performance of the U.S. economy, these stats are measuring the segments of the formal economy in which legal transactions occur. But we all know that there is a wide range of illegal transactions that also occur every day.

These transactions range from illegal activities like drugs and prostitution to activities that are perfectly legal, but the transactions themselves are technically illegal. An example would be payments made to employees or service providers in cash (or under the table) to avoid reporting the income and paying taxes on it.

Illegal transactions like these make up what is often referred to as the underground economy, or the black market. Here in the U.S., the underground economy is estimated to comprise up to $2 trillion in economic activity, or about 8 percent of the total U.S. gross domestic product (GDP). The IRS says that about $500 billion in taxes go uncollected annually due to under-the-table payments and unreported income.

Why the Underground Economy Is Growing

Some economists believe that the underground economy has grown considerably in recent years as the formal economy continues to struggle, unemployment remains high, and more people take part-time jobs for which they are paid under the table in cash. Many of these jobs are in restaurants and service industries, including domestic workers like housekeepers and nannies and day laborers in the construction industry.

Economists point to several trends as evidence of a booming underground economy. For example, consumer spending has remained strong, despite the stubbornly high unemployment rate and stagnant wages. In addition, the official labor force participation rate has dropped to its lowest level since the late 1970s. If all these people are spending all this money but don’t have official jobs, they must be earning money under the table, some economists conclude.

There is a wide range of economic activities that are included in the underground economy. In addition to illegal drugs and prostitution, they also include human trafficking, arms dealing, illegal logging, wildlife trade, illegal tobacco sales, trade in human organs, counterfeit and unregulated medicine, and copyright infringement of various types of media such as CDs, computer software and video games. Less pernicious, but still illegal, activities include unreported home services like carpentry, painting and gardening.

Worldwide, counterfeit pharmaceutical drugs constitute the largest black market, with an estimated annual market value of $200 billion. Next on the list are prostitution ($187 billion), counterfeit electronics ($169 billion) and marijuana ($142 billion). The money generated from all of these and other illegal activities is added to unreported wages that are paid under the table to unofficial workers to arrive at a total estimated value of the underground economy.

Impact on GDP

As noted, the illegal transactions that are conducted within the underground economy are not included in U.S. GDP calculations. However, several countries in Europe — including Great Britain, Spain and Italy — recently announced that they would start including revenue generated from prostitution and illegal drug sales in their official GDP calculations. In fact, new requirements mandate that all European Union member countries do exactly this.

Doing so can make a big difference in a country’s official GDP tally. In Great Britain, for example, including illegal activities in GDP would add about $17 billion, or 0.7 percent, to its GDP. For EU countries, increasing GDP can help meet debt-to-GDP and deficit-to-GDP ratios required in the euro zone.

There are no plans right now to include illegal activities like drug trafficking and prostitution in U.S. GDP, says the U.S. Bureau of Economic Analysis. The Bureau adds that it has not done enough research to estimate by how much adding these and other illegal activities to the calculation would boost GDP. In any case, most black market income eventually cascades into the legal economy, as it is spent on mainstream goods and services. The economic impact of this cascade, while sizeable, is also not tracked.

One thing does seem certain, however — the underground economy is here to stay. Despite law enforcement efforts to reduce drug trafficking, prostitution and other illegal activities and IRS efforts to track down under-the-table payments, these are not going away anytime soon, if ever.

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