The recent comprehensive coverage of the black economy’s scope and growth by the media shows how extensive black economy activities now are.
These activities are extensive, and they operate outside a country’s tax regulations and laws, which is a flaw to tax policing and economic management.
The Meaning Of Black Economy
The black economy is also known as the underground, shadow, or informal economy. It is a portion of the gig economy that operates off the radar, meaning some businesses and people do not report their income and tax obligations to the tax authorities.
Participants in this economy are mostly the unemployed and traders that want to make more money off illegal trades. Other people take part in the black economy for power, prestige, and self-esteem in the economic arena.
How Does Black Economy Work?
Black economy refers to money on which tax is not paid to the government. For instance, if a store accepts cash for all the goods or services sold/offered but does not issue receipts to the customers, that store operates in the black economy.
Another example of a black economy is when, for instance, a buyer purchases a real estate property valued at $500,000, and he/she only reports $100,000 on the books and pays $400,000 under the table, then that is a black money transaction worth $400,000.
Why Does Black Economy Exist?
To understand better how the black economy operates, we have to know why it exists in the first place. Here are the reasons why the black economy exists.
1. Government Regulations On Prices
A government might encourage the black economy if it imposes price ceilings or overregulates prices on goods, causing a secondary market.
This decision might encourage a shortage of certain commodities, prompting black market sellers to sell them, sometimes even at higher prices to willing buyers.
Jobless individuals who can’t access legal jobs in the mainstream economy may turn to opportunities in the shadow economy.
Such jobs could be as harmless as trimming a neighbors fence and receiving payment in cash without disclosing the income to relevant authorities.
3. Illegal Activities
You can contribute to the underground economy out of your free will if you undertake criminal and dangerous activities.
Such activities include drug trafficking, slave labor, human and organ trafficking, where sellers do not freely expose their products or income.
4. Government’s Strict Licensing Regulations
Some workers enter the shadow economy because of the licensing restrictions governments require for a venture to operate.
If getting licenses proves to be too expensive or time-wasting, people choose to run license-free businesses at least until the law catches up with them.
Sometimes, the underground economy does not exist out of people’s free will, but because their citizenship denies them the ability to work legally.
Since you need to make money, you may start ventures that might be as legal as selling hamburgers on the streets. However, because you don’t disclose your job and income to tax authorities to avoid jail terms or deportation, you encourage the black economy.
Examples Of Black Economy
Illegal gambling includes unlicensed and unauthorized online and physical gambling activities. For this reason, they are off the government’s radar, meaning they escape taxation do not contribute to public infrastructure.
The undeclared tips and winnings contribute to the shadow economy.
Shielding Legal Goods And Services From Taxation
These include undercover black markets of legal goods and services that exist everywhere and in plain sight. Such businesses lack licenses to operate, and therefore, their production and exchange are undocumented and untaxed.
Money laundering is the scheme criminals use to attempt to conceal the illegal source of their income.
They do this by “cleaning” their money by undertaking the transfers and transactions of their illegal activities through a stream of legitimate businesses to conceal the origin of their income and make it appear lawful business profits.
Transaction Of Off-Book Cash Wages
Off-book transactions mean that a firm or a business does not record their transactions in the accounting records to avoid paying taxes.
It also happens when employers pay undocumented service providers or when they conduct illegal transactions.
Smuggling in a country means that goods and services evade taxation because owners do not pay duty for them. These activities cause unbalanced trade between nations and the circulation of products the government has no control over.
Cash-Payment Of “under the table” Jobs
Any undisclosed income is a black economy. These jobs can include legal jobs like plumbing and construction or housekeeping. Although the work is permitted, you avoid tax as long as you receive after-service payment in cash.
The Impact Of Black Economy
1. Penalizes Legitimate Tax Payers
The government may impose heavier taxes on honest taxpayers to make up for the taxes the black market evades.
Apart from that, the shadow economy’s enablers free-ride on the tax contributions of legitimate taxpayers.
2. Creates Inequity To Legitimate Business Owners
The informal economy denies business from a legit venture. For instance, it happens if people opt for illegal goods because they are cheaper, causing fewer sales for lawful shopkeepers.
Apart from that, it gives more power to criminal operators who create problems and insecurities in the general public.
3. Tax Underestimation
Imperfect tax information for governments leads to incorrect tax policies that generally affect a nation’s economy.
4. Loss Of Revenue To The Government
The government cannot account for the actual economic operation because it cannot collect income or sales tax or exercise duty if it can not regulate the market. It loses revenue
For this reason, the government struggles to provide infrastructures that benefit its people.
5. Increase The Gap Between The Rich And Poor
Unregulated businesses operate on their terms without penalties or taxation. This means that they can take over the market and suppress other firms by flooding the market with cheap goods to willing buyers.
Income disparities widen the gap between the rich and the poor when illegitimate businesses increase while lawful ventures reduce or remain the same.
6. Low Safety Standards
The shadow economy is off-radar, meaning the government does not regulate the activities. For this reason, criminals and drug traffickers expose the general public to substandard goods that raise health concerns.
The black economy has adverse effects on our society as its growth encourages a situation where the rich keeps getting richer and the poor becoming poorer. Below are some key takeaways.
- Participants of the black economy prefer cash transactions over online transactions to not leave footprints of their dealings.
- Lost taxes in the underground economy costs governments billions of dollars in revenue.
- Participants of the shadow economy risk conviction and jail term for illegal activities or task evasion.
- Unfortunately, sellers in the shadow economy do not qualify for the government’s economic support in case of unprecedented economic disruption.