NCPA - National Center for Policy Analysis

Underground Economies Loom Large

September 25, 2000

Underground economies consist of legal activities that are concealed, mainly for reasons of tax evasion. Underground activity surged in the 1970s and remains a sizable part of many nations' economies. A recent study analyzed just how large these underground economies are:

  • The underground economies in some countries -- such as Spain, Portugal, Italy, Belgium and Greece -- are an estimated 22 percent to 30 percent of total gross domestic product (GDP).
  • Norway's underground economy grew from 1.5 percent of GDP in 1960 to 18 percent in 1995.
  • Underground economies represent 17 percent of the GDP of industrialized countries in the Organization for Economic Cooperation and Development (OECD).
  • In the European Union alone, 20 million workers are employed by the underground economy.

This represents a serious dilemma to many nations, as underground businesses do not contribute to the government's coffers and can have unsafe working conditions. The authors of the study cite several reasons for the continuance of underground activity.

  • Increases in tax rates like in the 1970s.
  • A large number of labor regulations in the European Union.
  • Extremely generous welfare systems in Scandinavian Countries.
  • High levels of corruption.

The authors claim high tax and regulatory burdens cause a cyclical pattern. An increase in the shadow economy brings additional pressure on public finance that results in higher tax rates, which again increase the incentives to evade taxes and escape into the shadow economy. They also note that underground economies rarely reemerge once established, even if tax rates fall.

Source: "Growing Underground," Economic Intuition, Summer 2000. Based on Friedrich Schneider and Dominik Enste, "Shadow Economies: Size, Causes and Consequences," Journal of Economic Literature, March 2000.


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