What is largely fueling the underground economy, experts say, is the nation's swelling ranks of low-wage illegal immigrants. The government puts this population at 8.5 million, but that may represent a serious undercount. Robert Justich, a senior managing director at Bear Stearns Asset Management in New York, makes a persuasive case in a forthcoming paper, "The Underground Labor Force Is Rising to the Surface," that illegal immigrants actually number 18 million to 20 million. If true, the economic implications are profound and could help shape debates slated in Washington this year over both immigration policies and tax reform.
Measuring the size of the underground economy is, of course, more art than science, since most of its denizens seek to remain anonymous. But convincing anecdotal evidence and a number of credible academic studies suggest that it is expanding briskly -- probably by an average of 5.6% a year since the early 1990s, edging out the real economy. [Underground illustration]
In the process, the underground economy is undermining the effectiveness of the Internal Revenue Service, which is highly dependent on employees' withholding taxes. If the IRS could collect all the taxes it says that it is owed from the underground economy in a given year, then the current budget deficit would disappear overnight. And if the IRS could collect these taxes every year, then the nation would have surpluses as far as the eye can see.
The IRS has estimated that its tax gap -- the estimated amount of taxes owed minus the amount collected -- is around $311 billion in any given year. The agency will produce a new estimate in 2005, and it could be as high as $400 billion, says former IRS Commissioner Donald Alexander. Now a lawyer in Washington, he cites a rise in private contracting and the opportunities it affords for not reporting income.
The gap number measures only a portion of the underground economy. Because the number is extrapolated from audited returns, it makes no allowances for criminal enterprises that report no income, and it even fails to capture some garden varieties of nonreporting. The unreported wages of illegal immigrants alone could be costing the government another $50 billion a year, says Justich.
Growth of the underground economy is partly a result of corporate downsizing, which has forced many former employees to go out on their own.
"We have had an 85% taxpayer compliance rate," says Nina Olson, the IRS's taxpayer advocate.
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