Key takeaways
– The underground economy (also called the shadow economy, black market, or informal economy) consists of legal or illegal economic activity that is deliberately not reported to authorities and therefore escapes official statistics and taxation. (Investopedia)
– It is hard to measure precisely because participants hide transactions. Analysts estimate the U.S. underground economy at roughly 11–12% of GDP in recent years (about $2.5 trillion in 2021), with earlier estimates of $1–2 trillion in the 2009–2013 period. (Investopedia; IMF)
– Effects vary by context: in some places the shadow economy undermines public revenue and growth; in others it can sustain livelihoods when formal employment is scarce or when governments are corrupt. (Investopedia; IMF)
– Common policy responses include simplifying regulation and taxes, strengthening enforcement, expanding financial inclusion and digital payments, and—where appropriate—legalization or decriminalization of some activities. (IMF; Investopedia)
Understanding the underground economy
Definition and scope
– The underground economy comprises transactions that are illegal because the good or service itself is banned (e.g., illicit drugs, smuggling, human trafficking) and transactions that are legal in nature but deliberately unreported to avoid taxes, regulation, or labor laws (e.g., cash “under‑the‑table” wages, unreported side gigs, untaxed sales). (Investopedia)
– It also includes barter or non‑monetary exchanges that are not recorded, and illicit markets for copyrighted goods, endangered species, antiquities, and organs. (Investopedia)
Why it’s hard to measure
– By design, activities in the underground economy are hidden from official records (tax filings, company reports, customs records), so researchers use indirect methods—tracking discrepancies between income and expenditure statistics, currency demand, specialized surveys, or model‑based estimates—to approximate its size. Tracking unaccounted outgoing expenditures is one practical approach to infer hidden transactions. (Investopedia; IMF)
Global underground economies
– Sizes vary widely across countries. An IMF cross‑country study found considerable variation in shadow economic activity across 158 countries over 1991–2015. In some low‑income or high‑corruption settings the shadow economy can be very large; in others (high‑trust, high‑compliance countries) it tends to be smaller. (IMF)
– Fast fact: Zimbabwe is estimated to have one of the largest underground economies (about 60.6% of GDP), while Switzerland is estimated among the smallest (about 7.2%). (Investopedia/IMF)
Which country has the largest underground economy?
– Based on the data referenced above, Zimbabwe tops the list by share of GDP (≈60.6%). Switzerland is near the bottom (≈7.2%). Note that different studies and years can produce different rankings because of methodology and changing conditions. (Investopedia/IMF)
What is considered “underground”?
Examples
– Illicit production and distribution (illegal drugs, illegal weapons, human trafficking). (Investopedia)
– Smuggling to avoid customs duties and purchase taxes. (Investopedia)
– Legal activities deliberately unreported to tax authorities or regulators (cash wages paid “under the table,” undeclared babysitting or side gig income). The IRS, for example, treats babysitting income as taxable self‑employment income and requires reporting if it exceeds specified thresholds. (Investopedia; TurboTax)
– Legal goods sold informally to avoid excise or sin taxes (e.g., a large share of cigarette sales in some jurisdictions are facilitated by the underground market to evade high tobacco taxes). (Investopedia; Tax Foundation)
– Barter and other informal exchanges that aren’t recorded. (Investopedia)
Characteristics of an underground economy
– Heterogeneous: includes both criminal markets and unreported lawful activity. (Investopedia)
– Opaque: transactions are deliberately concealed from authorities. (Investopedia)
– Responsive to incentives: high taxes, heavy regulation, and weak enforcement tend to expand shadow activity; so do limited formal job opportunities and deep corruption. (Investopedia; IMF)
– Can be both harmful and adaptive: it may reduce government revenue and distort competition, but it can also provide income and goods when formal channels are inaccessible or extractive. (Investopedia; IMF)
Why people engage in the underground economy
– To obtain banned or restricted goods and services (e.g., illegal drugs or contraband). (Investopedia)
– To avoid taxes, customs duties, licensing costs, minimum‑wage or labor protections, and administrative paperwork. (Investopedia)
– To generate income when formal jobs are unavailable, or when formal sector compliance costs are perceived as too high. (Investopedia; IMF)
– Motivations can also be political or ethical—e.g., refusal to pay taxes when the government is overtly corrupt or when public services are evidently poor. (Investopedia; IMF)
– Policy changes can move activity in or out of the shadows: example—legalization of cannabis for medical/nonmedical use in many U.S. states shifted previously illegal transactions into regulated, taxable markets. (Investopedia; PBS; NCSL)
Practical steps — how to measure, reduce, or avoid participation in the underground economy
For policymakers and public agencies
1. Improve measurement and diagnostics
• Use multiple methods (expenditure/income discrepancies, currency demand, targeted surveys, model‑based approaches) and cross‑validate results to estimate the size and composition of underground activity. The IMF’s reports and datasets provide methodologies and comparative findings. (IMF; Investopedia)
2. Reduce incentives for informality
• Simplify tax systems, lower excessive rates on small enterprises or petty trades, and reduce administrative burdens that push small operators offline. (IMF)
3. Strengthen institutions and enforcement
• Build capacity for targeted audits, customs control, anti‑money‑laundering measures, and enforcement against trafficking and illicit trade. Ensure enforcement is fair and transparent to increase compliance. (IMF; Investopedia)
4. Expand formal market access and financial inclusion
• Promote affordable digital payments, simplified business registration, microcredit and business development services so small vendors can operate formally and build credit histories. (IMF)
5. Consider policy reforms where criminalization causes harm
• In some cases, legalizing or regulating previously illegal activities (e.g., certain drugs) can shift activity into the taxed, regulated sector and reduce criminal markets—policy must be evidence‑based and accompanied by public‑health measures. (Investopedia; PBS; NCSL)
6. Fight corruption
• Reducing corruption raises the perceived value of compliance (people will be more willing to pay taxes if revenues are properly used). (IMF; Investopedia)
For businesses
1. Keep accurate, contemporaneous records
• Proper ledgers, invoices, and use of electronic payments reduce audit risk and help pricing, credit access, and compliance. (Investopedia)
2. Use digital payments and point‑of‑sale systems
• Encouraging noncash payments creates auditable trails and often boosts customer trust and access to formal financial services. (IMF)
3. Formalize early and take advantage of support programs
• Register for available small‑business tax regimes and support programs that reduce the initial cost of formalization. (IMF)
For individuals and consumers
1. Know and follow tax rules
• Small‑scale earnings (e.g., babysitting, gig work) are often taxable above specified thresholds; check local tax guidance and report accordingly (TurboTax provides guidance for some forms of self‑employment income). (TurboTax; Investopedia)
2. Avoid purchasing illegal goods or services
• Buying from the shadow economy can expose you to legal risk and safety hazards (e.g., unregulated substances or smuggled products). (Investopedia)
3. Prefer formal service providers when possible
• Using registered businesses helps ensure consumer protections, product safety, and contribution to public revenues that fund services. (Investopedia)
Detecting and monitoring trends (for analysts)
– Monitor indicators such as unexplained cash demand, discrepancies between reported incomes and observed consumption, VAT/excise gaps, registration trends for firms, and household survey reports of informal activities. Cross‑check multiple indicators to improve confidence in estimates. (Investopedia; IMF)
Policy trade‑offs and context
– Policies that fight the shadow economy must weigh enforcement against the costs of pushing vulnerable workers further into informality. In contexts with weak governance and deep poverty, immediate strict enforcement without alternatives can harm livelihoods. Conversely, unchecked shadow activity undermines public services and fair competition. Evidence‑based mixes of simplification, enforcement, anti‑corruption, and inclusive policies generally produce better long‑term results. (IMF; Investopedia)
Further reading and sources
– Investopedia. “Underground Economy.”
– International Monetary Fund. “Shadow Economies Around the World. What Did We Learn Over the Last 20 Years?” (2018).
– Dickinson. “Understanding the Shadow Economy.”
– CNBC. “$2 Trillion Underground Economy May Be Recovery’s Savior.”
– The Christian Science Monitor. “America’s ‘Shadow’ Economy Is Bigger Than You Think – and Growing.”
– PBS Frontline. “Marijuana Timeline.”
– University of Georgia. “Survey of Marijuana Law in the United States: History of Marijuana Regulation in the United States.”
– National Conference of State Legislatures. “State Medical Cannabis Laws.”
– TurboTax. “Do Babysitters Have to Report Their Income on Taxes?”
– Tax Foundation. “Cigarette Taxes and Cigarette Smuggling by State, 2018.”
Editor’s note: The following topics are reserved for upcoming updates and will be expanded with detailed examples and datasets.