Economics scholar points to a surging underground economy

April 13, 2009

by Dennis Chaptman

With the tax-filing deadline just days away, a University of Wisconsin-Madison expert in the underground economy says that unpaid tax liability in the United States has likely ballooned to more than $600 billion.

Edgar Feige, an economics professor emeritus, says that is a sign that the underground economy in the United States has grown considerably and that unreported income now amounts to between $2 trillion and $2.25 trillion annually.

"There has been a very dramatic increase in what's called the 'tax gap' during the past five years," says Feige.

The tax gap is the amount of true tax liability that is not paid voluntarily or in a timely fashion. The most recent year in which the Internal Revenue Service estimated the gap was in 2001, when the agency concluded that the gap had risen to $345 billion.

Feige's research — in a paper yet to be published — shows that the ratio of unreported income to reported adjusted gross income today is approaching the peak levels of the World War II period.

"That percentage declined during the postwar period and remained roughly stable until 1973, when it again rose to a temporary peak in 1982," says Feige. "The past decade has witnessed a rapid increase in the percentage of unreported income."

In 2008, unreported income as a percentage of adjusted gross income is estimated at between 22.2 percent and 24.4 percent.

The bulging tax gap and signs of a growing underground economy are major issues at a time of fiscal crisis for governments facing huge deficits that could be reduced by greater tax compliance, Feige says.

Feige's research springs partly from an analysis of U.S. currency in circulation. He says that currency in circulation at the beginning of 2009 hit an "astounding" $824 billion. That amounts to $2,700 for every man, woman and child in the country.

If all of that currency was held in the U.S., "the bulging average American wallet would hold 87 pieces of currency, consisting of 31 one-dollar bills, seven fives, five tens, 20 twenties, four fifties and 20 one-hundred-dollar bills."

That's in an age in which many people assume we're headed toward becoming a cashless economy, Feige notes.

"Clearly, these amounts of currency are not normally necessary for those of us simply wishing to make payments when neither credit cards nor checks are accepted or convenient," he says. "No one can account for who's holding that much currency."

His research also shows that roughly one third of U.S. currency is held overseas, significantly less than the 50 to 70 percent that earlier estimates indicated. That means the average American is holding more than $1,750 in cash.

Feige concludes that much of that unaccounted for cash has streamed into the underground economy and goes unreported to tax officials each year. As the recession deepens and regular employment opportunities decline, unreported activities tend to grow, thereby swelling the tax gap and worsening the government's budget deficit.