The Underground Economy in California – What Does it Cost?

The actual size of the underground economy is difficult to measure. Estimates are that underground activity in the United States in 2012 totaled as much as $2 trillion, according to a study by Edgar Feige, an economist at the University of Wisconsin-Madison. In 2012, the IRS released a new set of tax gap estimates for tax year 2006. The tax gap is defined as the amount of tax liability faced by taxpayers that is not paid on time. After adjusting for audit and collection activities, the IRS estimates that in 2006 the net national tax gap was approximately $385 billion. In its March 2015 report, California’s Little Hoover Commission indicated “The underground economy also robs the state of an estimated $8.5 billion to $10 billion in uncollected tax revenue, money that could fund education, law enforcement or long-overdue infrastructure investments or reduce taxes for the majority of Californians who play by the rules.

Barron’s Online featured the article, Going Underground, on January 3, 2005. This article states in part:

“America has two economies, and one is flourishing at the expense of the other. First, there’s the legitimate economy, in which craftsmen are licensed and employers and employees pay taxes. Then there’s the fast-growing underground economy, where millions of workers are paid off-the-books, their incomes largely untaxed.”

Reports on the underground economy indicate it imposes significant burdens on revenue needed to fund critical state programs and businesses that comply with the law. When businesses operate in the underground economy, they gain an unfair, competitive advantage over businesses that comply with labor, licensing, and payroll tax laws. This causes unfair competition in the marketplace and forces law-abiding businesses to pay higher taxes and expenses.

Workers of noncompliant businesses are also affected. Their working conditions may not meet the legal requirements, which can put them in danger. Their wage earnings may be less than what is required by law, and benefits they are entitled to can be denied or delayed because their wages are not properly reported. Consumers can also be affected when contracting with unlicensed businesses. Licensing provisions are designed to ensure sufficient skill and knowledge to protect consumers.

As illustrated above, the underground economy impacts not only businesses but workers and consumers as well.