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I've Always Wondered ...

How large is the shadow economy?

Janet Nguyen May 31, 2024
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This is just one of the stories from our “I’ve Always Wondered” series, where we tackle all of your questions about the world of business, no matter how big or small. Ever wondered if recycling is worth it? Or how store brands stack up against name brands? Check out more from the series here.

Tom Green asks:

How large is the underground economy — the cash exchange for goods and services, such as waiters’ tips, that are not reported to the IRS?

This shadow economy is made up of street vendors, musicians, babysitters, farm workers and anyone else who may not report income to the government.

Some people call it the shadow economy, the underground economy, the informal economy, the clandestine economy or the gray economy.  Whatever you call it (we’ll go with “shadow economy” from here), it’s worth trillions. One expert told us it could be worth as much as 10% of U.S. gross domestic product.

“It’s really sizable. I mean, if you think about it, that would make it right about the third-largest economy globally, behind the U.S. and China,” said James Saunoris, who’s studied the shadow economy at Eastern Michigan University. 

The thing is there’s no agreed-upon definition of the shadow economy. The International Labour Organization says it’s “all economic activities by workers and economic units that are — in law or in practice – not covered or insufficiently covered by formal arrangements.” 

The shadow economy can include any sale of goods between two individuals, said Kim Vu-Dinh, associate professor at the Mitchell Hamline School of Law. Think Craigslist and Facebook Marketplace.

Saunoris said he excludes criminal activity in his research, although not every economist does. “The reason why the focus may be on the non-criminal sector is because these activities would be considered part of GDP had they been reported. In other words, these activities may be considered ‘socially valuable,’” Saunoris said. 

For some disenfranchised people, it might be the only “real choice” they have to earn a living, Vu-Dinh said. 

“This is an economy that exists out of necessity for some people, not just a frivolous desire to evade the law,” Vu-Dinh said. 

Early in the 21st century, the global shadow economy was estimated to generate $10 trillion worth of economic activity, according to the publication Foreign Policy. These days that figure is likely closer to $15 trillion, Saunoris said, based on World Bank data and GDP estimates from researchers. .   

The U.S. shadow economy is about 10% of the country’s GDP, which means that it generates $2.5 trillion worth of economic activity, Saunoris said. But these are just estimates.

“You’re trying to measure economic activity that doesn’t want to be measured,” Saunoris said. 

For example, U.S. employers failed to report a total of $6.3 billion in tip income for the 2016 tax year, according to the Treasury Inspector General for Tax Administration. Full-service and limited-service restaurants accounted for $4.8 billion in unreported tips, while the amusement and recreation sector (which includes golf courses and gyms) accounted for $838 million in unreported tips.

The shadow economy is often more accessible and flexible, providing opportunities to less educated workers, folks struggling during economic downturns, undocumented immigrants, people of color starting their own businesses and women who want greater job flexibility, experts told Marketplace. 

But there are downsides. The shadow economy hinders the government’s ability to collect taxes, which can in turn reduce the quality and quantity of public goods; prevents employees from obtaining health insurance; creates unfair competition and distorts macroeconomic statistics, Saunoris said.  

Properly accounting for the shadow economy could raise the GDP and lower the unemployment rate, Saunoris said. And that has implications for policy making: for example, the Federal Reserve uses GDP as one metric when setting interest rates.  

Some employers also keep workers off the books so they don’t have to pay taxes or workers’ compensation, Vu-Dinh said. 

And employers might exploit under-the-table workers by paying them low wages. There’s also no recourse for workers who get hurt or die on the job, said Amy Schoenecker, an assistant professor of political science at the University of Hartford. 

While undocumented workers in the U.S. pay billions into Social Security, they do not receive benefits since they don’t have Social Security numbers and aren’t authorized to work in the U.S. Some countries have what’s called a monotax, which allows informal workers to still receive social welfare benefits, Schoenecker said.  

“So much of the informal economy is hidden, which is why it’s hard to understand, but we benefit from it,” Schoenecker said. “We are all attached to it, or have been involved with it at some point.” 

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