Our Economy Is Anchored Underground
Officially, California’s gross state product is $717 billion, unemployment is 7.7% and 3.8 million Californians live below the poverty line.
But we also know one more thing: Those figures are wrong, because what no one knows for sure is the effect of the state’s underground economy.
We do know--or we strongly suspect--that California’s unreported sector is growing. With perhaps 2 million illegal immigrants, large garment and construction industries and more than a million self-employed, the state’s economy is irrigated by a swelling flood of unreported income.
Says Roger Miller, who supervises the state’s feeble effort to uncover unreported business activity in Southern California: “It’s unbelievably large. We only touch a small part of it.”
How big is it? People guess. In 1985, the state’s Little Hoover Commission said $30 billion to $45 billion in economic activity was occurring off the books annually in California. Nationally, the Internal Revenue Service estimated that it lost $60 billion or $70 billion in taxes on legal unreported activity in 1987, implying a legal underground economy several times that figure.
The federal Bureau of Economic Analysis, assessing the question in 1977, figured on about 4% of gross national product, leaving aside crime, which would mean about $28 billion for California today. The bureau also figures that nearly three-fourths of this is attributable to sole proprietorships.
“That’s who cheat,” says economist David Levine at Sanford C. Bernstein & Co. in New York, who’s looked into this. “And they cheat to the tune of half their income.”
The implications are intriguing. Driven by the twin engines of entrepreneurship and a ruthlessly efficient labor market, all this cash activity is a big factor in the state’s persistently ruddy economy. It’s a factor far larger than the numbers would suggest too even if we could measure it.
Nobody’s condoning tax fraud, but like it or not, the ability of sole proprietorships to avoid taxes amounts to a massive subsidy to tiny businesses, which are flexible, efficient and generate lots of jobs.
And although small entrepreneurs seem to get most of the unreported income, immigrants and other off-the-books workers appear to account for a disproportionate share of subterranean employment.
Insofar as minimum wage, safety and other laws are flouted, this isn’t great, but for many workers the alternative to a Los Angeles sweatshop is Guatemala. As UCLA economist Jack Hirshleifer says, “Both parties to the transaction are happy.”
Better yet, all this work at strictly market wages stimulates the economy and raises efficiency. The readiness of off-the-books workers to care for children, cut the grass and perform other duties maximizes employment and frees those with greater skills--mainly women--for higher-paying jobs.
Off-the-books workers aren’t taxed, of course, but the IRS says most make too little to owe much anyway. They strain social services, but there’s evidence that the economic benefits outweigh the costs.
A chunk of underground activity involves drugs and other illegalities, of course, and even legitimate untaxed business activity breaks the law. But when it comes to unskilled workers, it’s as if we decided to grant the working poor a tax credit without paperwork, assuming they’ll forgo Social Security.
These facts imply something else important: That we’re all richer than we seem--even the poorest of us. At Northwestern University’s Center for Urban Affairs and Policy Research, for instance, Christopher Jencks and Kathryn Edin studied 25 Chicago welfare mothers and found that all supplemented their checks with unreported income. Jencks, a well-known student of poverty, guesses that many people do the same here.
“Everyone knows it occurs,” agrees Sally Brown, a research associate at UC Berkeley’s Family Welfare Research Group. “But no one wants to talk about it.”
In California, people work off the books building houses and sewing dresses, pruning trees and raising children, and in eateries and beauty parlors. Day labor is available for cash throughout Southern California, often supplied by illegal immigrants. UC San Diego economist George Borjas, who studies immigration, says there are perhaps 1.5 million to 2.5 million illegals statewide.
The system thrives partly because there’s so little enforcement. The state Division of Labor Standards has 37 professionals to enforce all the labor laws from San Luis Obispo to Mexico, a task so far-fetched that in construction, management and unions have formed their own watchdog agencies to report violations. Miller, who heads the state’s effort in Southern California, says the problem has increased “drastically” in recent years.”
Michael J. Quinn, the IRS district director for Los Angeles, says his agency doesn’t bother with day laborers and the like for back taxes, focusing instead on higher-income cheats who yield a richer lode.
None of this is to say society should forget about worker safety or collecting taxes. Cheating is bad for everyone, and in such a free-wheeling environment, exploitation flourishes. Clearly, we need to spend more on enforcement.
But we also need to acknowledge that the marketplace in California sure is efficient. And murky as the underground economy seems, it’s not about to go away anytime soon.
