It was last year, when the recession failed to arrive on time, that economists suspected there was something wrong with their numbers.
All the official statistics said a recession was coming. Incomes were pinched by inflation and families were burdened with record personal debt; consumer spending had to slow down soon.
But it didn't. Defying the statistically inevitable and confounding economists, consumers kept right on spending money they weren't supposed to have.
The recession forecast was wrong because Americans had far more money to spend than anyone recognized: a vast store of secret wealth that didn't show up on the official accounts.
Much of the uncounted cash came from "the underground economy," an unmeasured, unregulated, unpredictible financial empire whose size economists can only guess.
The estimates range from $135 billion -- a 1976 figure produced by the Internal Revenue Service and never updated -- to the $700 billion a year calculated by University of Wisconsin Professor Edgar Feige.
Middle-of-the-road estimates are that "unreported economic activity" in the United States now totals more than $400 billion a year, says City University of New York economist Peter Gutmann, who first suggested how big the phenomena had become. That would make it the sixth-largest economy of the world -- behind such official economic giants as West Germany, France, Great Britain, the Soviet Union and, of course, the United States itself.
By Gutmann's calculations, one out of every seven dollars is earned "off the books" and is neither taxed nor included in official government statistics.
Whatever its size, the subterranean economy appears to be growing faster than the rest of the system -- in part because inflation and high tax rates are sending more and more people underground.
Gutmann figures that 5 million to 6 million Americans earn their living exclusively from illegal or underground business and perhaps twice that many more supplement the income declared on their Form 1040 with some underground cash.
The dirtiest money in the underground economy comes from crime, mostly drugs. The Drug Enforcement Administration estimates that $70 billion to $90 billion was spent on illegal drugs last year. Counting prostitution and gambling, criminal entgerprises add up to one-third of the $400 billion Underground Economy.
But most underground income isn't inherently illegal. It's the cabdriver who leaves a few fares off the trip sheet, the waitress who pockets her tips tax-free, the street musician who works for money from bystanders, the retailer who takes home a television set and writes it off as shoplifting, the business traveler who skims the expense account, the unemployed worker who does odd jobs for cash while drawing jobless benefits, the family that "forgets" to count the $250 earned from its garage sale as income.
It's also the big business that incorporates in a Caribbean "tax haven" to avoid taxes, the small business that swaps its goods through one of hundreds of barter exchanges and the family that skirts inheritance taxes by investing in untreacable municipal bonds.
Most underground business is strictly for cash, resulting in unexpected growth in the amount of paper money in circulation. Despite the extensive use of checks, electronic funds transfer and credit cards, there is now more currency floating around than ever before -- about $600 for every man, woman and child in the United States, compared with $240 just 10 years ago.
Underground economic activities range from the petty larceny to the downright legal. Whatever the shade of gray, they are meant to hide money fromn the prying eyes of government. Not just the IRS, but the building inspector, the business license bureau and the welfare worker.
The usually mentioned motivations for legitimate business to go underground are to evade taxes, to keep from losing government benefits and to avoid regulations.
Federal, state and local governments lose incalculable billions of revenues because of the underground economy, but the tax loss is not the most important effect, says economist Feige.
Official economic statistics -- such as the cost of living, unemployment rate and gross national project -- don't measure the total U.S. economy, he contends. The inadequacies in the numbers "lead policy makers to take actions that transform economic errors into real economic maladies."
Government economists adjust some statistics -- notably farm income -- to account for underreporting, but the federal Office of Management and Budget makes no attempt to factor the underground economy into its economic forecasts.
"Everything is based on the official data," a spokesman said, in effect confirming the criticism.
Policy errors caused by ignoring unreported economic activity "tend to be inflationary," says Gutmann. Federal efforts to goad the economy may only cause inflation, becuse the system is already running at a higher level than the official statistics indicate.
With one conspicuous exception, the few economists who've seriously studied the subject agree on the implications of the United States' subterranean economy:
The gross national product is much bigger than officially reported -- at least 10 percent bigger and perhaps twice that.
Living standards are better than statistics indicate, becuse of all the income and investment hidden from the government.
The labor force is bigger than reported by 5 percent or 6 percent.
Unemployment is lower than reported. Gutmann estimates the actual rate to be 1 1/2 percentage points less than officially counted; Rather than the 7.6 percent reported in May, it would be more like 6.1 percent when off-the-books employment is counted in.
Productivity per worker is greater than reported, because GNP is understated by a greater amount than the size of the labor force. Productivity per person hour is also greater because so much output is skimmed off before being reported to the government.
Economic growth is greater than government statistics indicate, because the underground economy is growing faster than the measured economy.
Savings and investment are greater than usually thought. Much underground income is stashed away instead of being spent, and the existance of unreported income allows people to save more of their regular earnings.
Poverty is substantially less than the government says. Oregon State University professor Morton Paglin has calculated that less than 4 percent of the country lives belows the poverty line, rather than the 12 percent cited in official statistics. The government numbers don't count in-kind income such as food stamps and subsidized housing and doesn't admit that even poor people understate their income, he says.
On the subject of how the underground economy affects inflation, however, there is bitter disagreement between Feige and Gutmann, the two best known "underground economicsts."
Gutmann argues that inflation is really worse than the statistics show. Construction, retailing and services are the leading underground industries, he notes, and they have higher inflation rates than the rest of the economy.
Feige, however, says the lower prices available in the underground economy mean inflation isn't as bad as measured by the officials statistics.
"Economic analysis -- on which we depend for government policy and business and investment decisions -- must begin to take the underground economy into account," say economists at Werthein & Co., Inc. a major New York investment firm.
More than 100 Wall Street analysts and corporate economists turned out earlier this summer when Wertheim put on a seminar on the underground economy, prompted in part by last year's tardy recession.
The estimates of the size of the underground economy by Feige and Gutmann are indirect calculations that relate total economic activity to the amount of cash in circulation.
When underground activity is added to official statistics, "the U.S. economy looks altogether more robust," concluded Wertheim economists Thomas Klingenstein and Richard Bove.
The two looked closely at one particular economic statistic -- the ratio of total outstanding debt to gross national product. The ratio has been rising for the last two decades, seemingly indicating the nation is suffering under a growing burden of debt.
Not so, say Klingenstein and Bove. If you add the underground economy to the reported GNP, the ratio turns out to be virtually constant. The apparent increase in debt is a creature of biased statistics, not reality.
Businesses are beginning to grasp the implications of the underground economy and to intuitively adjust their economic planning to account for them, say Bove and Klingenstein.
Robert Mooney, manager of business economics for J. C. Penny Co. said the unexpectedly strong consumer spending that held off last year's recession demonstrated "that consumer purchasing ability is higher than is being measured by conventional indicators."
"There is more business available than reported income levels indicate because of the gap between total and reported income," he said, noting that the underground effect seems to be greater in urban areas. Sales of big ticket items and home improvements appear to benefit most from underground cash.
But Penney's also feels negative effects of the underground economy. The retailer has to compete for part-time workers with off-the-books employers who'll pay employes in cash, with no deductions. Shoplifting is encouraged by the ease with which stolen goods can be sold in the underground economy. Conventional stores are losing business to flea markets and yard sales, where no sales tax is charged and no income tax added to profits.
Even such giants as General Electric "complete to an increasing extent with suppliers from the underground economy," adds GE economist Walter Dolde.
He estimates that 20 percent to 25 percent of appliance repairs are now done by off-the-books entrepreneurs, and "a lot of underground competitors" have gone into the business of delivering appliances for retailers.
Once underground firms get a foothold in a field, they tend to quickly increase their market share by offering lower prices. With no licenses to apply for, no taxes to pay, no minimum wage to worry about, underground enterprises easily can undercut their legitimate competition.