Benjamin Li, Jessica Chen, Leon Xu

Benjamin Li, Jessica Chen, Leon Xu

Macroeconomics Project Summary Sheet: The Underground Economy

DEFINITION: The underground economy consists of any and all market transactions which are hidden, illegal and/or unreported. It is also known as the black market, shadow economy or parallel economy.

COMMON EXAMPLES: Drug trade, prostitution, “under-the-table” wages, and labour with informal payment such as babysitting or landscape labour (mowing lawn, shoveling snow).

CAUSES

● Saving Money/Tax Evasion: The underground economy appeals to consumers with lower prices. Transactions which take place do not require sales tax payment.

● Illegal Goods/Services: Drugs such as cocaine or heroine are exchanged illegally in the underground economy to avoid punishment.

● Informal Jobs: “Second-rate” jobs typically reserved for youth, such as car washes, bake sales, etc. have unofficial cash payment for labour.

● Lack of Contract: Labour suppliers may scam consumers. E.g. in the construction industry, if a contract is missing builders can’t be sued for incompetent production.

● Increasing Minimum Wage: Companies will hire fewer workers, which results in higher levels of unemployment. Many unemployed workers (especially unskilled labourers) will look to the underground economy for work, where employers may hire them for lower wages, paid “under-the-table” to avoid detection from the law.

● Price Ceilings: Shortages occur when price ceilings are imposed on suppliers, so consumers turn to the black market to purchase their desired goods/services, even if prices are above the price ceiling. Suppliers lose the incentive to produce high quality goods, affecting consumers’ decisions to purchase from these firms.

● Lack of Jobs: Unemployed workers resort to working in the underground economy.

○ Immigrants also resort to working here if they don’t have the legal status to work, since they could be punished if caught working officially without the status to do so.

PROBLEMS & CONSEQUENCES

● Illegal Activity: Growth of the underground economy also represents an increase in the corresponding illegal affairs, raising the risk for punishment.
e.g. prostitution, drug trade, weapon sales and hacking services.

● Inequality: While some people aren’t paying their taxes, they still receive the same government-provided services funded from the taxes of law-abiding citizens.

● Difficulty in GDP Calculation: Unrecorded transactions cause inaccurate statistics. As a result, policies or other studies based upon GDP have inaccuracies as well.

○ Expenditure-based-GDP = Personal Consumption + Gross Investment + Government Purchases + (Exports - Imports)

○ Unreported transactions within personal consumption, gross investment or trade make it difficult to accurately measure Canada’s GDP.

● Less Tax Revenue: With a substantial portion of the market in the underground economy, this can weaken public services funded by taxes. Such services include: healthcare, education, pensions, childcare and employment insurance.

● Scams: Consumers are at a higher risk of being scammed, especially in the residential construction sector where cash payments are frequent.

UNDERGROUND ECONOMY IN CANADA

● In 2013, the underground economy accounted for approximately 2.4% of Canada’s GDP (up to $45.6 billion).

● This value has remained relatively stable since 2002, ranging from 2.2% at the lowest to 2.7% at the highest.

● The 3 industries which contributed to over half of its value: residential construction (27.8%), retail trade (12.5%), and accommodation + food services (11.7%).

● Expenditure-based-GDP: household expenditure contributed to 65.2% of the underground economy.

● Income-based-GDP: labour compensation (wages/salaries) to employees contributed to 46.9% of the underground economy; 2.2% of GDP equalled any compensation not officially recorded in payroll and unauthorized tips.

UNDERGROUND ECONOMY IN ONTARIO

● Makes up ⅓ of Canada’s underground economy; estimated to be worth $15 billion.

● Residential construction accounts for ~ 30% of Ontario’s underground economy.

● Ontario government took action by creating specialized teams of auditors to find tax evaders and target electronic sales suppression devices/software (“zappers”).

POTENTIAL SOLUTIONS

● Raising Penalties: If harsher penalties for illicit activities are created, the risk may discourage people from using the underground economy.

● Lowering Legal Market Prices: If prices for demand inelastic goods such as cigarettes or alcohol are lowered, people will not need to resort to the underground economy as much. However, for many of these high-priced goods, the government is also trying to discourage their use, which may conflict with the idea of lowering prices.

● Legalization of Certain Goods/Services: The legalization of drugs such as marijuana has been at the centre of debate during recent years. If these drugs are legalized, they may be sold in the legal market without having to break the law.

● Spreading Awareness: Telling people to report suspected tax evasion to the CRA (Canadian Revenue Agency) can help track/reveal illegal activities.

Works Cited

Battista, Caroline. "This Is How The Underground Economy Shortchanges Canadians." The Huffington Post. The Huffington Post, 28 Dec. 2016. Web. 11 June 2017.
Canada, Government Of Canada Statistics. "The underground economy in Canada, 2013." Government of Canada, Statistics Canada. N.p., 20 June 2016. Web. 11 June 2017.
FCA, Gabe Hayos FCPA. "The Underground Economy Is Eroding the Integrity of Our Tax System." The Huffington Post. The Huffington Post, 15 July 2016. Web. 11 June 2017.
Ferreras, Jesse. "1 Segment Of Canada's Economy Hasn't Shrunk In Over A Decade." The Huffington Post. The Huffington Post, 20 June 2016. Web. 11 June 2017.
Floyd, David. "Underground Economy." Investopedia. N.p., 22 Feb. 2016. Web. 11 June 2017.
Golombek, Jamie. "There's a hidden cost to Canada's underground economy, worth a staggering $45.6 billion." Financial Post. N.p., n.d. Web. 11 June 2017.
Government of Canada, Canada Revenue Agency, Domestic Compliance Programs Branch, Small and Medium Enterprises Directorate. "About the underground economy." Government of Canada, Canada Revenue Agency, Domestic Compliance Programs Branch, Small and Medium Enterprises Directorate. Government of Canada, Canada Revenue Agency, Public Affairs Branch, Electronic and Print Media Directorate, 08 Mar. 2017. Web. 11 June 2017.
Government of Ontario, Ministry of Finance. "Consultations." Addressing Ontario's Underground Economy in the Residential Construction Sector: Interim Report for the Minister of Finance On Behalf of Parliamentary Assistant Laura Albanese, MPP. Ministry of Finance: Government of Ontario, n.d. Web. 11 June 2017.
Johnston, Matthew. "How Big Is the Underground Economy in America?" Investopedia. N.p., 29 Mar. 2016. Web. 11 June 2017.
Laurence. "Home." Canadian Electrical Wholesaler. N.p., n.d. Web. 11 June 2017.
Lu, Vanessa. "Ontario cracks down on underground economy, goes after tax cheats." Thestar.com. N.p., 25 Feb. 2016. Web. 11 June 2017.
MacDonald, Chris. "How big is Canada's underground economy? $42 billion." Canadian Business - Your Source For Business News. N.p., 04 May 2015. Web. 11 June 2017.
Maverick, J.B. "How the Underground Economy Affects GDP." Investopedia. N.p., 19 Aug. 2016. Web. 11 June 2017.
Ministry of Finance. "Ontario Seeking Input to Address Underground Economy." News.ontario.ca. N.p., 12 Jan. 2016. Web. 11 June 2017.
Moniquemuise. "Canada’s underground economy is thriving. So are you contributing?" Global News. N.p., 21 June 2016. Web. 11 June 2017.
"Ontario Seeking Input to Address Underground Economy." News.ontario.ca. N.p., n.d. Web. 11 June 2017.
Pettinger, Tejvan. "The Size of the Black Economy." Economics Help. N.p., n.d. Web. 11 June 2017.
Pettinger, Tejvan. "Underground Economy." Economics Help. N.p., n.d. Web. 11 June 2017.
Writer, Staff. "The size of Canada's underground economy." The Globe and Mail. The Globe and Mail, 16 Aug. 2016. Web. 11 June 2017.