$2 trillion underground economy aids recovery

Mark Koba, Senior Editor at CNBC | CNBC

The growing underground economy may be helping to prevent the real economy from sinking further, according to analysts.

The shadow economy is a system composed of those who can't find a full-time or regular job. Workers turn to anything that pays them under the table, with no income reported and no taxes paid — especially with an uneven job picture.

"The underground economy is quite big in the U.S.," said Alexandre Padilla, associate professor of economics at Metropolitan State University of Denver. "Whether it's using undocumented workers or those here legally, it's pretty large."

"You normally see underground economies in places like Brazil or in southern Europe," said Laura Gonzalez, professor of personal finance at Fordham University. "But with the job situation and the uncertainty in the economy, it's not all that surprising to have it growing here in the U.S."

Estimates are that underground activity last year totaled as much as $2 trillion, according to a study by Edgar Feige, an economist at the University of Wisconsin-Madison.

That's double the amount in 2009, according to a study by Friedrich Schneider, a professor at Johannes Kepler University in Linz, Austria. The study said the shadow economy amounts to nearly 8% of gross domestic product.

Much of that money goes into cash registers, said Gonzalez, as personal consumption has risen since the recession.

"There is consumer spending in the short term, with people having money even if it's not reported, and that's boosting the economy," she said. "But in the long run, an underground economy is telling us that things have to change."

Shadow economies are usually associated with illegal activity, such as drug dealing. But anecdotal evidence indicates that off-the-books work in today's job market includes personal and domestic workers, such as housekeepers and nannies.

"The jobs are in service industries from small food establishments to landscaping." said David Fiorenza, an economy professor at Villanova University. "Even the arts and culture industry is not immune to working off the books in areas of music and entertainment."

It also includes firms that hire hourly or day construction labor, information technology specialists and Web designers. Many who have a job that doesn't pay enough take another one that pays under the table.

"We've always had people who make income without recording it, so it's not really new," said Peter McHenry, an assistant professor of economics at William & Mary College. "But the fact that more and more people are doing it shows how bad the job picture is," he added.

The reasons behind the underground economy's growth are fairly simple, according to Gonzalez.

"There's a lot of uncertainly about immigration changes and who will be legal, and about paying for Obamacare," she said, adding that most workers in the shadow economy are in the country illegally. "Government rules are keeping businesses from hiring."

A report from ADP Research Institute states that many employers, especially in low-wage businesses such as retail and food service, plan to reduce workers' hours to less than 30 a week to avoid having to offer health insurance benefits under new requirements of the Obama health care law (or pay a fine).

"This type of regulation could put more people out of work and into an underground economy," McHenry said.

But employers have their own agenda, according to Padilla.

"Businesses are not angels, and they exist to make a profit," Padilla said. "They are going to do everything they can to keep costs down, and if that means paying people off the books, they will do it. The government doesn't really have the resources to track down every business that does this."

What the government is keeping track of is lost revenues. According to the Internal Revenue Service, about $500 billion in taxes were lost last year because of unreported wages vs. $384 billion in 2001.

"The effects of the underground economy are larger than we think," said David Fiorenza. "The result is less tax money paid to the various levels of government."

"Those working and not paying the taxes puts the burden on those who pay the tax," added Fiorenza. "Taxes could be lower if the government where able to capture the underground economy instead of raising taxes on those currently paying the various income and payroll taxes."

But the dangers of a shadow economy go beyond dollars and cents, analysts said. Workers who aren't on the books don't get Social Security or health benefits, and worse.

"People who do these types of jobs run the risk of getting exploited with lower pay or not being paid at all," Gonzalez said. "There could be more exploitation if more people are forced into this type of economy."

"Some income is better than none, but there is a reason we have certain regulations in place to protect workers and what they do," McHenry said.

In the end, what's happening below the normal economy should not come as too much of a shock, according to Gonzalez.

"People are running out of patience when it comes to finding a job and losing income," Gonzalez said. "So it's not that surprising to have workers take jobs that are in the shadow economy. But it's a sign of how bad things are and how we have to get the real economy moving again."

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