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What California’s Growing Underground Economy Says About Sacramento

The underground or “black economy” generally refers to transactions that go unreported to evade taxation. Most people associate this with …

The underground or “black economy” generally refers to transactions that go unreported to evade taxation. Most people associate this with the illegal drug or sex industries but when government policies seek to reach further into private activities it often has the effect of driving activities that are normally above ground such as repair, services, and construction into cash or barter transactions.

Countries such as the U.S., Switzerland and Japan historically have had relatively small, nonreporting and/or illegal sectors, a typical estimate falling between 8 percent and 13 percent of GDP. Most European countries with higher taxes and regulation report underground economies of at least 20 percent of GDP with countries such as Italy and Greece having at least 30 percent of all economic activity going unreported.

Economic studies have shown that when people believe the taxes they are required to pay are reasonable and the political leaders tend to spend their tax dollars wisely, tax compliance rises, and when the reverse is true more economic activity is driven underground. California is showing signs that it is beginning to share one more characteristic with countries such as Greece and Italy: Its black economy is on the rise.

Last December, the LA Times reported that Sacramento officials are increasingly agitated by employers who pay their workers cash under the table to avoid payroll taxes, workers’ compensation insurance and other government mandates. This is in addition to smuggled cigarettes and counterfeit apparel. Officials believe that these underground activities are costing California about $7 billion annually in lost tax revenue. They report that this undercuts companies that play by the rules.

California’s underground economy is said to go beyond the usual products like counterfeit clothing designer hand bags, pirated DVDs and smuggled cigarettes that are sold in flea markets and street corners, and state officials have vowed to crack down. Normally, such indicators might tell state leaders that the Golden State’s tax and regulatory regime may perhaps have gone too far. After all, for the last eight years CEOs surveyed by Chief Executive have consistently indicated that they think California is the worst state for business because of punitive taxes and regulations. So, why are we not surprised that more the state’s economy is being driven underground?

According to a recent story by Sacramento TV station Fox 40, the California Board of Equalization (BOE) which focuses on such things as smuggled and un-taxed cigarettes, now wants to expand its reach into more activities. BOE Chief of Investigations Randy Silva said the black economy costs the state as much as $8 billion a year in uncollected revenue. And he might get help from the state legislature. Senator Curran Price (D-Los Angeles) has authored Senate Bill 1185, which creates a Centralized Intelligence Partnership and brings separate state agencies together. The bill would would facilitate consumer complaints, chiefly by rewarding whistleblowers and assist in various investigations, prosecute violations and re-capture unreported taxes.

Every state has the right to see its laws enforced but the question remains whether such legislation will achieve this result. In recent years the general public has become aware that many people in government advocate higher taxes and argue that everyone has a responsibility to pay. Yet many such officials, namely the secretary of the Treasury and chairman of the House Ways and Means Committee have sought to evade paying “their fare share” of taxes. Not surprisingly, more citizens seek to evade these taxes themselves. In a state with the country’s highest tax and regulatory burden it isn’t surprising that the behavior of California’s citizens edge closer to those of Italy, who have a long history of thumbing their noses at the tax man.

About J.P. Donlon

J.P. Donlon
J.P. Donlon is Editor Emeritus of Chief Executive magazine.