The phenomenon of underground economy can be observed all around the world, regardless of a country´s state of development. It has been studied and discussed in literature for several decades. In the 1980s the size of the underground economy in the United States was higher than during World War II for the first time, and it continued to grow due to tax increases in the 1990s. In addition, globalization and the resulting greater competition as well as the increasing number of unregistered immigrants give rise to unrecorded activities.
In this paper I will focus on the causes and effects of the underground economy in the United States. Therefore, I will first explain the main motivators for individuals to take action in the unofficial economy, such as a legal framework consisting of high tax schemes and social security burdens as well as the institutional quality in terms of bureaucracy and regulatory discretion.
Second, I will examine some of the most affected sectors. In this context I will especially concentrate on underground immigrants, contraband trade, and money laundering as well as labor-intense services undertaken by not-registered workers.
Finally, I will address the results and effects of the underground economy on the recorded one and its labor and money markets. In this section of the paper I will also show how the U.S. underground economy is related to other phenomena such as the budget deficit, the “gray area phenomenon” and corruption.
In the final part of the paper I will focus on possible solutions to reduce the extent of underground activities. I will especially emphasize some methods to measure and estimate invisible economic action on the one hand and on the implementation of policy engagement on the other.
A brief conclusion in the end sums up the main points and provides an overview of the aspects developed in this paper.
At a glance
- Grade: 2.0 (1.0 is the best grade)
- Examines underground immigrant activity in New York
- Discusses direct, indirect, model and empirical approaches to measurement
- 22 sources in the bibliography
Table of Contents
1. Introduction
2. Causes and motivators
2.1 The legal framework and institutional quality
2.2 Globalization and additional motivation
3. Affected sectors
3.1 Underground immigrants in New York
3.2 Contraband trade and money laundering
3.3 The service sector
4. Results and effects
4.1 Consequences
4.2 The "gray area phenomenon" (GAP)
5. Options and solutions
5.1 Measurement and estimates
5.2 Policy implementation
6. Conclusion
Objectives and Themes
This paper examines the causes and effects of the underground economy in the United States. It asks what motivates participation in unrecorded activities, how those activities relate to the legitimate economy, and what measurement and policy approaches might address them.
- Taxation, regulation and institutional quality
- Globalization and individual incentives
- Underground immigrant activity in New York
- Contraband, money laundering and unreported services
- Economic effects and the gray area phenomenon
- Measurement approaches and policy options
Excerpt from the Book
2. Causes and motivators
People might decide to operate in the unofficial economy for various reasons. These can basically be classified into two categories. There are external causes such as the legal business environment and institutional quality, as well as globalization and personal motivators that influence the decision of whether to engage in underground activities or not.
2.1 The legal framework and institutional quality
The most important reasons for the growth of the shadow economy are “costly regulation, rising tax rates and growing distrust of government” (Feige 1994: 24). The National Center for Policy Analysis (1998) also confirms “as tax rates rise, hiding income becomes more profitable”.
In this context, Dreher and his colleagues (2008) mention the burden of high taxation and social security contributions on the one hand, and institutional quality on the other, as the primary causes for underground activity. As individuals seek to keep their profits, they avoid participation in the official system. The latter aspect, institutional quality, refers to bureaucracy, regulation, a weak legal system, and corruption. The authors conclude that there is a positive relation between bureaucracy and the underground economy.
In the U.S., an increase in underground activities is also a consequence of downsizing staff in many business establishments, that led many jobless persons to go underground, as well as a result of rising online commerce, where the taxation is basically the sellers´ responsibility (McTague, 2005).
2.2 Globalization and additional motivation
In contrast to the causes mentioned above, Karlinger (2008: 1-2) identified some aspects of globalization in the late 1990s that finally increased underground activities. These include the reduction of trade barriers, market liberalization, and the improvement of communication and transportation. The result of such developments was an increase of competition in the legitimate economy as well as the unregistered one, driving more individuals underground. Competition forces economic agents to reduce their input costs, and especially labor is much cheaper without taxation and safety or health standards.
According to Frey and Schneider (2000: 5-6), there are also personal considerations responsible for the decision of participation in the underground sector. First, they mention working time restrictions in terms of few hours, long vacation, and early retirement as reasons for additional employment in the unregistered economy. Second, there is an incentive for self-employed persons and illegal immigrants, as in their case, the expectation and the expected extent of punishment for underground activities is quite low, especially compared to their possible gains. Third, there is a relationship between engagement in the shadow economy and its morale costs, which constitutes the individual component influencing the decision.
Chapter Summaries
1. Introduction: Introduces the underground economy in the United States and outlines the paper’s examination of its causes, affected sectors, effects and possible responses.
2. Causes and motivators: Discusses taxation, institutional quality, globalization and personal incentives as factors associated with participation in underground activities.
3. Affected sectors: Examines underground immigrant activity in New York, contraband trade, money laundering and unreported work in the service sector.
4. Results and effects: Considers the relationship between underground activity and the recorded economy, including public finances, corruption and the gray area phenomenon.
5. Options and solutions: Reviews approaches to estimating the underground economy and discusses potential policy measures.
6. Conclusion: Brings together the paper’s main points and suggests a direction for further research comparing state-level government action.
Keywords
underground economy, United States, shadow economy, tax evasion, institutional quality, globalization, immigration, contraband, money laundering, service sector, gray area phenomenon, economic measurement, public policy
Frequently Asked Questions
What is this paper about?
It examines the causes and effects of the underground economy in the United States and considers ways to measure and address it.
What are the main themes?
The paper covers incentives for underground activity, affected sectors, economic consequences, measurement and policy responses.
What is the paper’s primary objective?
Its primary objective is to explain why underground activities occur, how they relate to the recorded economy and what options exist to reduce their extent.
What research method does the author use?
The author reviews and discusses existing literature and published estimates to examine the underground economy and possible responses.
What does the main body discuss?
It discusses legal and institutional incentives, globalization, immigrant activity, contraband, money laundering, services, economic effects and policy options.
Which keywords characterize the paper?
Key terms include underground economy, tax evasion, institutional quality, immigration, money laundering, measurement and public policy.
Why does the paper discuss New York?
It uses New York to focus on immigrant participation in underground activities and draws on published accounts of the city.
What is the gray area phenomenon?
The paper describes it as threats to the stability of nation states posed by non-state actors and nongovernmental processes and organizations, and discusses its connection to underground activity.
Which approaches to measuring underground activity are discussed?
The paper refers to direct, indirect, model and empirical approaches developed by authors including Frey and Schneider and Tanzi.
- Quote paper
- Raffaela C. M. Wallner (Author), 2008, The U.S. Underground Economy, Munich, GRIN Verlag, https://www.grin.com/document/164332
