The Underground Economy: How Much Did the GDP Really Grow?

by Elaine Schwartz    •    Apr 27, 2013    •    4181 Views

Having reported yesterday that the GDP grew 2.5%, the Bureau of Economic Analysis (BEA) reminded us that their data “are incomplete or subject to further revision.” They meant that businesses and individuals still have more information to gather and submit about US goods and services production for the first quarter of 2013.

But what about the nannies, tutors, housecleaners and cupcake bakers who never reported their income? For nannies alone, in 1994, there were 500,000 tax filings; by 2008, the number dropped to 219,000. Fewer nannies? Probably not.

Some data, the BEA will never find out.

Researchers estimate that the size of the underground economy–the goods and services we produce that do not get counted–totals $2 trillion, close to 8% of US production. You can translate $2 trillion into $500 billion in unpaid taxes. In advanced economies, maybe 14-16% of all production is underground while in the developing world, 30%-40%. Predictably, for the euro zone’s strugglers like Greece, the underground economy might occupy one quarter or more of all production.

If we eliminate illegal goods and services like drugs, we can define the underground economy as all legal goods and services that are intentionally concealed from government to avoid taxes and/or other regulations. As a result, participants receive lower wages, they work longer hours. Businesses do not comply with quality standards; they are more susceptible to corruption. Correspondingly,  the taxes to support government programs never materialize and the nannies who never paid their social security will never receive it.

But still, if the reason is a complex tax system with lots of forms–a system that has a high transaction cost, for some noncompliance is productive. Also, with the underground economy   having increased during the great recession, it could have been a lifesaver for the unemployed.

Perhaps, an increasing underground economy means that first quarter GDP growth is more than 2.5%?

Your opinion?

Sources and Resources: Having read the BEA first quarter GDP news release, I recalled James Surowiecki’s New Yorker article on the underground economy. Surowiecki and a subsequent CNBC article lead me to a wealth of research. One solid discussion, here, presents the academic perspective and research and this briefer note focuses on nannies.

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