Academic journal article The Yale Law Journal

The Underground Economy: New Estimates from Household Income and Expenditure Surveys

Academic journal article The Yale Law Journal

The Underground Economy: New Estimates from Household Income and Expenditure Surveys

Article excerpt

Morton Paglin shows how a misplaced reliance on households' reported income distorts governmental assessments of the underground economy in the United States. He proposes a solution that incorporates households' reported expenditures and shows how this information can be used to formulate more rational macroeconomics and poverty policies.

This essay develops new estimates of the size of the underground economy in the United States, based on an analysis of the household reports of income and expenditures published annually in the Bureau of Labor Statistics Consumer Expenditure Survey (CES).(1) Most of the economic literature on the underground economy has focused on the information-distorting effects that unreported economic activity has on the National Income and Product Accounts (NIPA)(2) and on the macroeconomic models that use this data. This concern may be misplaced. In recent years the Bureau of Economic Analysis (BEA), which prepares the national income and product figures, has worked to incorporate a large part of underground economic activity into the NIPA totals. A less recognized deficiency is in our household income statistics, where underreporting of income, along with other factors, has undermined the validity of one of our most important social indicators: the poverty rate.

Before delving into the statistical material that constitutes the core of this Essay, I will briefly review some conceptual approaches to the underground economy. Part I presents the economist's view of the underground economy in contrast to a simple law enforcement approach. Part II, using data from the CES, examines the reluctance of some households to report income fully (or at all), compared with their willingness to report expenditures. This comparison becomes the starting point for new estimates of the underground economy, covering the years 1984 to 1992. Part III carries forward the analysis of household income and expenditures by using the individual micro-data available on public-use tapes,(3) rather than the group averages shown in the published bulletins. Because households are unwilling to report fully, if at all, the income they receive from underground activity, reported household income statistics are a deceptive indicator of poverty status; but a dual standard, employing both income and consumption expenditures, allows us to separate the truly poor from the phantom poor. Part IV uses the insights gained from the analysis of income and expenditure data in Part III to reveal the limitations and defects of the official poverty statistics derived from the Current Population Reports (CPR).(4) Finally, this Essay shows that a few simple remedial measures could mitigate the distorting effects that unreported income has on our poverty statistics, and make those statistics more truly representative of the number of persons actually living below the poverty thresholds.(5)

I. THE ECONOMIC APPROACH TO THE INFORMAL ECONOMY

The rationale for the law enforcement approach to the underground economy is straightforward: society through its elected representatives makes decisions to tax, constrain, or prohibit certain activities; unless these laws are enforced, there will be an erosion of confidence in the political process and in the institutions of democratic government. The economic approach, on the other hand, is less resolute in its condemnation. Laws and activities are evaluated in terms of economic efficiency and welfare criteria: Are the gains greater than the losses, so that real output is increased? Are the parties in a transaction made better off with little or no negative effects on others? Viewed in these terms, some underground activities can be shown to have net benefits; whereas, in other cases, particularly the sale of illegal goods, such as drugs, the detrimental effects predominate. In general, the existence of an underground activity on a wide scale may be a useful signal that the law is not effective and should be revised or repealed. …

Search by... Author
Show... All Results Primary Sources Peer-reviewed

Oops!

An unknown error has occurred. Please click the button below to reload the page. If the problem persists, please try again in a little while.