The underground economy consists of concealed legal economic activities undertaken to evade taxes or illegal economic activities (i.e., trafficking, drugs, and prostitution) with unreported barter and cash transactions that take place outside recorded market channels. These types of barter and cash transactions are hard for government authorities to trace and are the lifeblood of the underground economy.
These underground activities are often very productive and are not included in the gross domestic production (GDP). In the United States the underground economy is estimated to make up 10 to 15% of the total economic output. The underground economy is even larger in areas like Western Europe and South America due to regulation and/or higher tax rates (Gwartney, Stroup, Sobel, & Macpherson, 2013).
According to the Encyclopedia of Business Ethics and Society the underground economy encompasses any economic activity that is not reported to the government (2008). The three basic reasons for the underground economy is because individuals and firms are (1) dealing in illegal goods and services, (2) they want to avoid paying taxes on the income earned, or (3) they want to avoid government regulations. The most important thing to understand is that the greater the size of the underground economy, the smaller the size of the GDP (Grammy, 2011).
Historically, Italy and Russia have underground economies that account for 30% or more of their economic activities. In countries like Sweden, Denmark, and Norway typically the underground economy makes up about 20% of the GDP. In countries where corruption is widespread like Somalia, Iraq, and Nigeria it is estimated that 70% of all economic activities come from underground economies. Countries like the United States, Switzerland, and Japan have relatively small underground economies (Grammy, 2011). The underground economy is encouraged by things like excessive taxes, regulations, price controls, state monopolies, failure to recognize or enforce private property rights (Hall, 2008).
Thought the United States has a relatively small underground economy compared to other countries it still is estimated at about 10 percent of the GDP. In 2011 the GDP was standing at more than $15 trillion which made thesize of the underground economy at about $1.5 trillion, of which it is estimated that $1.1 trillion was generated in illegal activities and $400 billion came from off-the-books activities. It is believed by some economists that the off-the-books activities are rapidly rising due to the depressed economic conditions and growing illegal immigration (Grammy, 2011). The Encyclopedia of Business Ethics and Society suggests that if taxes could be collected on these trillion dollars in the underground economy then the federal budget deficit could be wiped out (2008).
Grammy, A. (2011). The underground economy. Economic Research Center. Retrieved from http://www.csub.edu/kej/documents/economic_rsch/2011-11-28.pdf Gwartney, J., Stroup, R., Sobel, R., & Macpherson, D. (2013). Economics: Private and public choice (14th ed). Independence, KY: Cengage Learning. Hall, A. (2008). Underground Economy. Encyclopedia of Business Ethics and Society, 5, 2131-2131. Retrieved from http://go.galegroup.com.ezproxy.liberty.edu:2048/ps/i.do?action=interpret&id=GALE%7CCX2660400835&v=2.1&u=vic_liberty&it=r&p=GVRL&sw=w&authCount=1.