The Underground Economy - Part 1 - The Hidden Tax


The underground economy is driving a hole in the collection of income taxes, social security, unemployment and Medicare to the tune of hundreds of billions of dollars annually within the United States. Yet significant questions remain about how big the problem is, as well as what should be done about it. Dire lessons can be learned from countries that have allowed tax evasion to become the norm. With estimates of rates ranging from 30-48% in countries like Greece, Italy and Romania, it isn’t surprising that the remaining tax base is completely insufficient to keep government afloat.

While the U.S. doesn't rise to that level (yet) when it comes to fraud as well as businesses evading obligations, including taxes, the gap raises a number of significant issues:

  • Failure by individual businesses, and in fact, large portions of entire industries, to appropriately report and pay taxes results in a revenue gap forcing cuts in services or other significant decisions. Studies show that most of the federal budget deficits in recent years would have been eliminated completely if income taxes were accurately reported and paid.
  •  When businesses don’t contribute to social security, unemployment or workers’ compensation coverage, as well as fail to follow health and safety rules, their employees are put at risk of bodily and financial harm. This can result in a long-term drag on other social services, exacerbating the financial gap noted above.
  • A business that fails to pay local, state and national taxes can gain a cost advantage of 30-40% over their honest counterparts. Within some industries that have tight margins, like restaurants or groceries, that can be the difference between continued operations and bankruptcy. In other industries, where there is bidding and price competition, ranging from construction to janitorial services, they undercut legitimate competitors and win the work.
  • As the title implies, there is another impact – the firms that don’t pay into these taxes and provide coverage like unemployment and workers’ compensation end up raising the tax rates for all the others. This “hidden tax” is something that states in the U.S. are starting to study and pay more attention to as they address the underground economy. One way to think of this is the same way that studies from the insurance industry show that fraud is increasing our auto insurance rates by 10% overall, and higher in some areas.

Within the U.S., the Internal Revenue Service (IRS) publishes a study on the “tax gap” every 5 years. The last study, released in 2012, showed a total gap of 16.9%. In other words, only 83.1% of income taxes were reported and paid. Not surprisingly, compliance rates were much higher among individuals that drew regular paychecks working for a separately-owned company that reported those to the government. The worst compliance rates were amongst self-employed businesses and farms.

During my time with the underground economy task force in Washington State, we utilized the methodology from the IRS to estimate our own gaps, just looking at business revenue and income taxes, unemployment and workers’ compensation. Net underreporting stood at $704 million annually, but we all knew this was underestimating the size and scope of the problem.

While some businesses actively evade compliance, others are unwittingly non-compliant due to the sheer complexity of the laws. Compounding this problem of non-compliance is the growth of the disruptive economy.  As companies that allow informal relationships and part-time business spread, like UberX and Airbnb, existing gaps widen significantly.  Some Uber drivers don't consider what they are doing to be "business" at all, and tend to fail to report that as income.  Added to that is potential fraud in failing to disclose their commercial business to their insurance companies, which would generate much higher rates, and the problem begins to compound.  These innovative developments in the new economy and  new customer interactions, driven by technology,  should be supported but laws, regulations, and education need to catch up quickly to prevent a rapid spread of the gray economy.

Recently, I had the opportunity to join a roundtable in the province of Ontario, Canada, that brought together regulators and public officials, the Chamber of Commerce, economists, and individuals that represent this disruptive economy, including the Canadian CEO of Airbnb.  The discussion was lively, and we came up with many opportunities to improve.  Hearing Airbnb say "please regulate us" was a breath of fresh air, and represented their desire to be good corporate citizens that just want clarity.

This background definitely leads to more questions – what are the problems, and where do they stem from? What can government do to help stem the tide? In the next two parts of this blog series, I will address those areas as well. In the meantime, please follow me on Twitter @CarlHammersburg and join the conversation.



About Author

Carl Hammersburg

Manager, Government and Healthcare Risk and Fraud

Carl Hammersburg manages the SAS Government and Healthcare Risk and Fraud team, and has been with SAS since 2012. Prior to that, he spent 20 years in anti-fraud activities for Washington State’s exclusive workers’ comp insurer, the Department of Labor and Industries. In 2004, Carl formed that agency’s comprehensive fraud program, covering tax and premium audit, claim investigation, provider fraud and collections. Data sharing and investigative partnerships with other State and Federal agencies, as well as driving public availability of information and awareness served as cornerstones to the anti-fraud activities of the program. During his stewardship, audit and investigative activities doubled and outcomes tripled, based on a focus on data mining and predictive analytics that improved efficiency and case selection. Program success under Carl’s leadership resulted in awards from two successive Governors of Washington State.


  1. Robert Allison
    Robert Allison on

    Interesting blog post! Yep - when people cheat on taxes, benefits, insurance, etc ... the rest of us end up paying for it. In this data-rich age, I'm hoping we can use analytics to cut down on the cheating, and save the honest people a ton of money!

    • Carl Hammersburg
      Carl Hammersburg on


      Thanks for taking the time to add to the conversation. I've seen the power of analytics first hand in detecting these issues and handling them quickly, both here at SAS, and in my former life as a government exec in Washington State. Your points are a direct lead in to Part 3 of this series, so stay tuned!


  2. Pingback: The Underground Economy - Part 2 - A Growing Problem

  3. Reuel Paradis on

    I wish you and yours a Wondrous New Year.
    Your article lays a strong foundation for a serious discussion about the underground economy. I am looking forward to the other parts of your article. I believe the road to higher voluntary compliance with tax laws is strong compliance enforcement. But strong compliance enforcement requires the will of the governed to support their elected representatives to create a body of law the requires strong compliance enforcement all of the current law that allows LLCs, corporations and the like to avoid personal responsibility for their actions - cheating on the taxes.
    Stay safe and keep up this good work.

    • Carl Hammersburg
      Carl Hammersburg on


      Thanks for taking the time to read the blog and comment. I appreciated the opportunity to work alongside you for years in government in Washington State, and saw your dedication to effective enforcement, which is truly a balance, not letting noncompliance slide, while at the same time, avoiding a heavy-handed approach.

      My thoughts on all of this have evolved over the last couple of decades. You are quite correct that it does start with the people, elected officials and body of law. Once I began engaging in the legislative process, it opened my eyes. Furthermore, the opportunity to work with many different states and countries in recent years has expanded my view of what is and isn't working across various jurisdictions, and cemented the view that to be truly effective requires a number of different things:

      - Underlying laws that are clear and provide appropriate incentives for honesty and penalties for cheating
      - Analytics and data-matching to detect non-compliance
      - Appropriate staffing and willingness to enforce compliance laws
      - A desire to ensure that information and education is readily available to promote voluntary compliance

      Again, thanks for taking the time to comment, and I hope you keep reading. Happy New Year.


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