Posted on 07/13/2004 9:34:54 AM PDT by Remember_Salamis
The underground economy Bruce Bartlett (archive)
July 13, 2004
Last week, the Organization for Economic Cooperation and Development in Paris issued a new report on the underground economy. This is only the latest study showing that a large fraction of employment and production in major countries as well as developing nations is taking place off the books, unrecorded in national accounts and untaxed by governments.
According to the report, the underground economy varies from 1.5 percent of gross domestic product in the United Kingdom to almost half in the Kyrgyz Republic. The OECD does not present data for the United States, but there is much data showing that it is a growing problem here, as well.
A recent book, "The Shadow Economy: An International Survey" (Cambridge University Press) by economists Friedrich Schneider and Dominik Enste, estimated the U.S. underground economy at between 6.7 percent of GDP and 13.9 percent in 1990, depending on the method used for calculation.
One common method is to look at currency in circulation as an indication of underground economic activity. By its nature, such activity is done almost entirely in cash so as to avoid detection by the authorities through checks or credit cards. On this basis, underground economic activity in the United States has probably risen sharply since 1990.
According to the Treasury Department, in 1990 there was $1,105 of currency in circulation for every American. By March of this year, that figure had risen to $2,455, an increase of 122 percent. It is highly unlikely that all of this increase is due to the needs of consumers to buy more goods and services, because per capita personal consumption expenditures only rose by 79 percent over the same period. This suggests that at least 35 percent of the increased demand for cash was for underground economic activity.
A further indication that this is the case is shown by looking at the composition of currency in circulation. Since 1990, 84 percent of the increase in currency is accounted for by $100 bills. Such bills now represent 71 percent of the monetary value of all U.S. currency, up from 52 percent in 1990. Average people do not ordinarily use $100 bills, but they are used heavily in the underground economy, which includes drug dealing and other illegal activity. Hence, it is reasonable to assume that the increased demand for $100s is due almost entirely to an increase in the underground economy.
Of course, even if this is true, it doesn't necessarily mean that the underground economy is growing here. U.S. currency is the medium of exchange of choice for underground activity worldwide. Indeed, 45 percent of U.S. currency circulates outside the United States for this reason. According to the Commerce Department, the United States "exported" $16.6 billion in currency last year, almost all of it in the form of $100 bills.
The former chief economist for the International Monetary Fund notes that the European currency, the euro, is now competing for the underground economy's business by having 500 euro notes, worth more than five times the U.S. $100, the largest bill printed by the Treasury in more than 50 years. He notes that $1 million in $100s would fit in a briefcase, but $1 million worth of 500 euro notes would fit in a purse -- a big advantage in the underground world.
The underground economy results from many factors, including criminal activity. But the bulk of it arises from ordinary businessmen and workers who are evading taxes and government regulations. The OECD downplays the importance of taxes and puts most of the responsibility on regulation. However, other studies have found that high tax rates are the most important factor in stimulating growth of the underground economy.
"In various surveys, the tax burden has always been identified as the main cause for the growth of the shadow economy," according to Schneider and Enste. Their analysis found that a 10 percentage point increase in the tax burden would cause the underground economy to rise by 3 percent of GDP. A Federal Reserve study found an even higher response, with an increase in the tax rate from 9.3 percent to 10 percent leading to a 1.5 percent rise in underground output.
A recent IMF study found that the composition of taxation was very important. High taxes on small businesses and the self-employed were most likely to lead to underground economic activity. "Raising tax rates too high drives firms into the underground economy," the study concluded.
One indication that taxes are stimulating tax evasion here is that the amount of income reported on tax returns has fallen compared to the amount of income paid as calculated by the Commerce Department. This income gap tends to rise and fall with the tax burden.
Whether caused by taxes or regulations, it is clear that government is the prime cause of the underground economy.
Bruce Bartlett is a senior fellow at the National Center for Policy Analysis, a Townhall.com member group.
How many people have a 40% marginal rate?
Most single proprietors, who pay full 15.3% payroll taxes plus high income taxes, and by IRS measures make up the bulk of non-compliance/evasion. Interesting the same most likely type of business to attempt to evade/avoid collecting the NRST from their customers.
You're also not including state sales taxes.
Hmm, we should add another 8% or so for states on the marginal rates for state income/payroll taxes as well which brings the max marginal rate up towards 50% on those small single proprietor businesses.
Point is, anyway you measure it the NRST offers no more incentive for evasion than the income/payroll tax today, and with 10% of the number of collection points, there are substantially higher risks of getting caught.
Here the total sales tax rate would be over 30% (over 40% with the required NRST rate).
If you want it use tax exclusive measures as it looks like you want to try to use, the marginal rates on income/payroll taxes comes out in excess of 200% taking both state & federal marginal rates into account.
Lets see, 40% sales tax, vs 200% income/payroll taxes. Not even a contest.
Sorry, 200% tax exclusive rate with respect to income/payroll taxes really should be 100%.
Most single proprietors, who pay full 15.3% payroll taxes plus high income taxes, and by IRS measures make up the bulk of non-compliance/evasion.Why do you suppose single proprietors make up the bulk of non-compliance/evasion?
We should expect at minimum a 5% evasion/avoidance with a NRST and I would say it would be closer to 10%.
Evasion/Avoidence under the current income/payroll tax system exceeds 10%.
Of cource the AFT's 29.87% rate assumes 0% evasion/avoidance.
Actually teh 23% NRST legislated rate assumes the same underground cash economy would exist as exists now 10-15% of GDP. The 23% NRST rate is confirmed with NIPA consumption as its taxbase which does not include iillegal and underground cash economies in its consumption expenditure totals.
As you have been informed before.
GDP/NIPA, measurements can only account for legal and measurable transactions outside the cash underground economy That same cash underground economy that makes up the bulk of evasion today, will make up the bulk of evasion under the NRST.
That cash economy is not accounted for in the GDP/NIPA statistics and thus provides the same implicit compensation as income tax rate calculations do today, where the tax base for income taxes is reported income already reduced because of evasion/avoidence.
Actual consumption is greater than the personal consumption figures NIPA reflects, GDP/NIPA leaves an outstanding discrepency of around $8000 per family in cash purchases not accounted for GDP/NIPA statistics.
http://spruce.flint.umich.edu/~mjperry/Unit10.html
| PROBLEMS WITH GDP - 1. Nonmarket production - Nonmarket production is excluded from GDP because there is no way to accurately measure it. Only actual "market transactions" get counted in GDP. Nonmarket production includes household production like fixing your own car, repairing, fixing, painting your house, working on your garden, growing your own food, cooking, the work of a housewife/househusband, etc. Estimated to be 10-15% of GDP, or about $1T/year. Example: If you eat out a restaurant, the value of the meal counts in GDP since it was a market transaction. If you eat the same food at home, only the value of the food counts and your "nonmarket production" (cooking) is NOT counted in GDP. If you hire someone to clean your house, it adds to GDP. If you clean your own house, it doesn't count for GDP. *** 2. Underground economy - could also easily be another $1T, or 10-15% of GDP from prostitution, drug trafficking, gambling, smuggling, illegal gun sales, tax evasion, etc. Also unreported cash income from cash business - taxi drivers, waiters/waitresses, bars, craftspeople, carnivals, fleas markets, illegal immigrants, etc. *** Evidence: There is about $500B of currency in circulation, for about 250m people, that means there is $2000 currency outstanding per person x 4 persons per average household = almost $8000/family in CASH!! |
Any tax rate calculation based on GDP/NIPA numbers is grounded in only the accessible tax base, and is implicitly compensated for tax evasion and avoidance.
Why do you suppose single proprietors make up the bulk of non-compliance/evasion?
It is easy to not report income when you are one individual hiding among 150million others, getting away with it is pretty good odds for a 100% increase in paycheck don't you think?
On the other hand, under the NRST, being 1 of 18 million certified businesses puts one in line for much closer scrutiny for a lot less reward. Especially with any volume you have any number of nominal customers that can turn you in for a liability only you as the seller are subject to.
It is easy to not report income when you are one individual hiding among 150million others, getting away with it is pretty good odds for a 100% increase in paycheck don't you think?WRONG! Thanks for playing.
. I'm talking about new evasion/avoidance caused by the high sales tax rate. Some examples: personal use bought with business exemption, off-shore mail-order purchases, barter, legal foreign purchases, failure of seller to pay tax collected, etc.
All of which exists under the current tax system, and are used in evasion of income/payroll taxes.
Incentive under the income/payroll tax system to evade = 100% increase on the margin with nil chance of discovery (one person not filing is all that is required to evade the tax).
Incentive under NRST 40% increase on the margin with odds of detection increasing with customer volume, the profitability margin for evasion falls for any decrease in price enticing customers with a break on paying sales tax.
There is no reason to assume that non-compliance/evasion will be greater under an NRST as compared to the current system.
The reason is no one else is reporting his income.
A_G:"It is easy to not report income when you are one individual hiding among 150million others,"
The IRS doesn't have any idea he owes money or how much he owes unless they do an audit.
random audits bring the odds to x in 150million as I said.
Just like no one else will be reporting collection of sales tax with a NRST.
Unhappy customers, rewards, and law enforcement stings. Any volume at all and you standout like a sorethumb.
The more you have to depend on others to stay quiet, the less secure you become.
A_G:"with any volume you have any number of nominal customers that can turn you in for a liability only you as the seller are subject to."
"Thanks for playing"
:"It is easy to not report income when you are one individual hiding among 150million others,"That's not my point. It's not easy to hide if someone else is reporting your income.
random audits bring the odds to x in 150million as I said.Except you are gutting the federal enforcement agency that does the random audits and not giving the states any incentive to pursue the federal sales tax. So it's 0 in 150 million odds.
Also, as you have been informed, your evidence of currency in circulation is weak. The vast majority of that is out of the country.
The number of hands it passes through is the determiner of how a dollar counts for consumption or income for that matter. Dollars don't just get used once and disappear. They are counters in the flow of the economy the rate at which the flow from person to person is the determinate of the tax base.
Finance & Development, March 2002 - The Surprising Popularity of Paper Currency
In fact, surveys of domestic households and businesses can account for only 5 percent of the U.S. currency in circulation. Where is the rest, the other 95 percent? A big chunk is probably held abroad, though estimates vary wildly from 30 percent to 75 percent (my 1998 Economic Policy article estimated 50 percent). Even if the number is at the high end, say, 75 percent, that still leaves $2,200, held domestically within the United States, for every family of four. Economists presume that most of this cash can be found in the "underground economy." The term brings to mind gangsters and drug dealers, but, quantitatively, the underground economy consists mostly of small businesses and entrepreneurs (and their customers) who are avoiding various forms of taxation.
You want to take a stab as how many hands that money goes through in a year as well as barter in kind on top of that? Its anybody's guess as it looks to me. Those folks who actually are participating in an underground economy are not very likely folks who are going to be telling anyone just how much cash they move around in their transactions from hand to hand several time a year.
Which is essentially why GDP/NIPA and CBO will never have a number reflecting the full actual base of income or consumption, They only know of those lesser amounts that are actually tracible and hence accessible for taxation on which the tax rates, of necessity, reflect.
Thus any rate calculation based on the GDP/NIPA numbers is ground in only the accessible tax base, and is implicitly compensated for tax evasion and avoidance.
It's not easy to hide if someone else is reporting your income.
Illegal & underground cash economy happens to be what we are talking about. INo ones reporting your income, t is certainly easy to hide cash and barter are the quantities being hidden which is what happens in evading the income/payroll tax system. One person hiding income is all it takes to evade income/payroll taxes in cash and barter situations.
The NRST on the otherhand requires volume business with people any of whom can turn you in should you not collect the tax and provide a proper reciept of a certified business subject to audit and other enforcement measures of the state the business is in.
and not giving the states any incentive to pursue the federal sales tax.
They run parallel with their own collections receiving an administrative fee for timely collection and remission to the US treasury. States are very interested when it comes to their own revenues.
Oops, ur odds just went up a bunch, specially considering the more customers the greater your risks of someing going for a bounty or enforcement sting.
They have no clue how big it really is. I mean huge.
The State of Texas has about 450 people for sales tax collection. That's not nearly enough to meet the increased incidence of evasion/avoidance that will occur with the increased incentive of the much larger NRST. The "administrative fee" for NRST collection is about $2500 for every $1,000,000 collected. I doubt any state would even hire one addition collection agent for that amount.
Anyway, at least you are admitting there will be evasion/avoidance. Now it's just a matter of how much and adjusting the rate accordingly.
The State of Texas has about 450 people for sales tax collection. That's not nearly enough to meet the increased incidence of evasion/avoidance that will occur with the increased incentive of the much larger NRST. The "administrative fee" for NRST collection is about $2500 for every $1,000,000 collected. I doubt any state would even hire one addition collection agent for that amount.
When the Comptroller for the State of Texas testified before the Ways & Means Committee in 2000, as to the adequacy of their being able to take on the FairTax administration, they certainly did not indicate they would have any such problems. In fact just the opposite.
Anyway, at least you are admitting there will be evasion/avoidance. Now it's just a matter of how much and adjusting the rate accordingly.
Since evasion/avoidance is already implicitly removed from the tax base by using GDP/NIPA numbers the 23% tax rate takes care of the problem nicely. Remember, incentive to evade higher and risk is lower under the current system. The magnitude of the problem is likely to get better not worse under HR15.
If you are looking for the NRST to have higher rates, that's too bad. The rate is set in the legislation as 23%. You want more go talk to a democrat. They are interested in higher rates, I and the HR25 folks are not.
For my part I am lobbying for an even lower rate justified on the Bush tax cuts which have taken place since that 23% was first determined. 20% or lower sounds better and justifiable to me.
You can always go lobby for your own rates, I'm not interested unless they are the same or lower than the 23% as stated in the legislation.
H.R.25, S.1493
A bill to promote freedom, fairness, and economic opportunity by repealing the income tax and other taxes, abolishing the Internal Revenue Service, and enacting a national retail sales tax to be administered primarily by the States.
Refer for additional information: http://www.fairtax.org & http://www.salestax.org
I doubt any state would even hire one addition collection agent for that amount.
Hmm! Not even a Texas tax-o-crat with a vested interest in growing his fiefdom makes that claim.
| http://waysandmeans.house.gov/legacy.asp?file=legacy/fullcomm/106cong/4-11-00/4-11hami.htm Statement of Billy Hamilton, Deputy Comptroller, Testimony Before the House Committee on Ways and Means Hearing on Fundamental Tax Reform April 11, 2000 My name is Billy Hamilton, and I am the Deputy Comptroller for the State of Texas. Carole Keeton Rylander, the Texas Comptroller of Public Accounts, was delighted to receive an invitation to testify before this committee regarding the Fundamental Tax Reform measures under consideration today. Unfortunately, Comptroller Rylander's schedule did not permit her attendance, and she has asked me to testify here on her behalf. My comments today are directed only to the feasibility of state administration of the Fair Tax proposed by H.R. 2525. I do not intend to comment on the economics or any other aspects of the proposal. The Texas Comptroller's office has administered a sales and use tax since the 1960's, and I have been involved with administration of the tax since 1982. Last year, the Texas Comptroller collected $13 billion in sales tax revenue from more than 600,000 businesses. I offer my own experience with sales tax administration, as well as the size of Texas' sales tax program, as the basis of my qualification to speak to you about the administerability of H.R. 2525. As you know, H.R. 2525 would permit states to collect and administer the Fair Tax on behalf of the federal government. In my opinion, Texas would be well-equipped to administer the Fair Tax based on our experience in administering our own sales tax. Even though the base, rate and other characteristics of the Fair Tax are significantly different from the Texas sales tax, it would be feasible for our office to collect the Fair Tax by expanding and enhancing the systems we currently have in place. For example, we would:
The expansion of our systems to administer the Fair Tax, in the manner I've just described, would be sizable. Under the Fair Tax, we would serve approximately 900,000 more filers than we do currently. We estimate that serving that many additional taxpayers would require 1,100 to 1,600 more full-time employees. The Texas Comptroller currently employs about 2,700 people on a full-time basis. In spite of this large expansion, the compensation for collecting the Fair Tax that would be provided to states under H.R. 2525 would likely cover our projected costs. As a first approximation, we estimate that the cost to the Texas Comptroller's office for collecting the Fair Tax at full implementation would be $100 to $150 million per year. I emphasize, however, that there would be significant costs to begin collection, including the cost of facilities to house the additional processing facilities, the capital costs of information technology and revenue processing equipment, and the costs of notifying, registering and educating taxpayers on the new tax. In closing, I believe that if the Fair Tax is to become a reality, the U.S. government would be well-served to make use of the existing expertise of the states. Many states have administered consumption taxes since the 1930s and have developed particular capabilities in this area. We also have extensive experience in dealing with the affected businesses. As long as the administrative fee paid to the state is adequate in relation to the costs of collection, I see no reason that the State of Texas could not effectively administer the Fair Tax. |
Where in the article does it talk about a sales tax??? You just made that up.
Made what up?
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