Government agencies have a way of conferring respectability on ideas, and that's just what the Internal Revenue Service has done for the "underground economy." Until recently, this was just another random subject for newspaper and magazine stories. Now the IRS has delivered a heavy report estimating that perhaps one dollar in every 10 of income has gone underground and is not reported for tax purposes. Suddenly we have a full-scale social problem.
Only economists and sociologists, who will receive more money for research, are likely to benefit from this development. Otherwise, it's a striking example of today's sloppy use of language or (more cheerfully) of our inventiveness in phrase-making. The "underground economy" implies that you have to take an escalator to a separate stratum of buying and selling, where you will find a distinct class of economic players.
With a few exceptions, nothing could be further from the truth. The underground economy is actually an amalgam of old practices uncomfortably jammed together under a new label: crime, tax evasion on legally received income, black market activities and old-fashioned neighborliness -- with perhaps a touch of larceny.
The impetus for this repackaging is largely political. Many of the people promoting the underground economy (though not necessarily the IRS) want you to believe that it's a reaction to the squeeze on living standards caused by inflation and high taxes. People contrive more ways to receive untaxed income. They perform jobs for cash, which they don't report, and underreport the earnings they actually do receive.
Thus, to get the economy above ground, reduce taxes and inflation. It's a neat argument.
Too neat, probably. The logic is unassailable. If the government imposed a 90 percent marginal tax rate on extra income, people either would go fishing or find some way around the tax system. But the evidence that this sort of behavior recently has increased sharply is skimpy at best. Even if it has, it still constitutes only a small part of the underground economy.
Common sense tells you that most of the crime and tax evasion has been occurring for years. The IRS acknowledges that its estimates of crime (artificially limited to gambling, prostitution and drug trafficking) are, in a word, lousy. Conceding that, it put total personal income in 1976 at $1.2 trillion, and said about 2 percent to 3 percent stemmed from crime and another 8 percent to 9 percent was earned legally but not reported for tax purposes.
But on that legally earned portion, the IRS study comes to the unsurprising conclusion that people cheat when they have the best chance of getting away with it.
Between 97 percent and 98 percent of all wages and salaries are reported on tax returns, mainly because employers withhold and report those earnings. The compliance rates on interest income (84 percent to 90 percent) and dividend income (84 percent to 92 percent) are also high, because most of that income also is reported separately to the IRS. Banks, for example, report interest on savings accounts; most companies similarly report dividends.
The slippage occurs when there isn't such double reporting. Only about two-thirds of self-employment income, for instance, is thought to be taxed, and only one-half to two-thirds of rent payments. The contention that these compliance rates suddenly have changed dramatically in response to inflation or higher tax rates takes a mighty benign view of human nature.
Ditto for crime.
To think, moreover, that anything one person does for another in which cash changes hands is some sort of conditioned reaction to inflation is to ignore the complexity of social relations. Neighbors, friends and relatives surely have been doing odd jobs for each other -- some for pay, some not -- for decades and not reporting the income to the IRS.
When researchers from the University of Michigan and Wayne State University actually studied the "irregular economy" in Detroit, this is precisely what they found. People with electrical wiring problems, for example, did about half the work themselves or relied on free services from family and friends; the other half was divided roughly between casual (paid for) arrangements in the "iregular economy" and bona fide contractors. The bigger the job, the more likely it was to be in the "regular economy."
If any distinction emerges from the IRS report, it is a crude one between people living in the "sheltered" and unsheltered" economies. People in the sheltered economy work for large organizations: governments and big companies. Most of these people get annual wage increases that keep them roughly even with inflation. Many enjoy substantial fringe benefits, ranging from lavish expense accounts to untaxed contributions for health and pension plans. Their organizational affiliation protects them from many insecurities of economic life.
The inhabitants of the unsheltered economy span the income spectrum: Actors and actresses, owners of small businesses, farmers, taxicab drivers, independent truckers and criminals. Some do very well; many don't. But they all face much greater year-to-year uncertainty. They struggle more, and have more opportunities to chisel. Is there a rough justice?
Maybe. What is certain is that the underground economy, like every "new" discovery, now is bound to be exploited for a variety of political purposes. On the one hand, it will be used by those urging lower tax rates. Likewise, the IRS will use it to push its current proposal that there be a flat 10 percent withholding on fees to such "independent contractors" as trucker owner-operators, real estate agents and franchise owners.
These aren't trifling matters, but we shouldn't interpret the novelty of the underground economy as a great upsurge in tax cheating. The whole concept wrongly romanticizes and sanctifies the rebellious behavior of the "underground" character who eludes Big Government. The perverse result is to encourage more tax evasion because ordinary taxpayers are likely to consider themselves fools, and worse, dull fools.