The Boston Herald reports that a Commonwealth of Massachusetts task force recovered more than US $21 million in wage restitution, state taxes, unemployment contributions from employers, fines, and penalties between July 2011 and December 2012. The state's Joint Enforcement Task Force on the Underground Economy and Employee Miscalculation investigates employers in the so-called "underground economy" that may be misclassifying workers to avoid wage, payroll tax, insurance, and other requirements. Often, employers pay these workers in cash or declare them as independent contractors. In one case, the task force uncovered US $1.17 million in unreported wages by subcontractors on a large construction project. State officials say such actions cheat taxpayers, deny workers unemployment or workers compensation benefits, and put companies that play by the rules at a competitive disadvantage.
Most experts agree that the size and complexity of the underground economy — essentially defined as an economy or market in which goods or services are traded illegally — continues to grow, particularly in the currently uncertain economic environment. The traded goods or services themselves may or may not be illegal, and in this case they deal more specifically with unreported income that was caught by regulators.
A 2012 U.S. Internal Revenue Service study indicates that about US $500 billion in taxes were lost last year because of unreported wages, versus US $384 billion in 2001. Some argue that the growing underground economy may be helping to prevent the real economy from sinking further, as workers are forced to take any work that pays them, even under the table, with no income reported and no taxes paid. Conversely, there is a taxation fairness issue: Taxes could be lower if the government were able to capture the underground economy instead of raising taxes on those currently paying various income and payroll taxes. Moreover, workers who aren't on the books don't get Social Security or health benefits.
Auditors working in a wide range of sectors (not just in the area of taxation) ought to be on the lookout for underground economic activities that are illegal or fraudulent — avoiding taxes, skimming of revenues, and theft may all be involved. Both employers and employees also may be involved. A few of the types of higher risk businesses include construction/renovation/home maintenance, restaurant/hospitality, transportation, automobile repair, and personal services (e.g., babysitting). An overall strategy to combat underground economic activity should address these elements:
Enhanced risk profiling and detection. Risk-based audit plans should strive towards better targeting of organizations, processes, and individuals that are most likely to engage in illegal underground economic activities. An increasingly large variety of information from third-party sources and more sophisticated risk-profiling techniques is available, and increased research, cooperation, and information-sharing are key tools.
- Greater use of regulatory, management, and financial controls that remove some or all discretion in the informal handling of money. Increased use of matching techniques, such as comparing income disclosed on tax returns to other sources of income information, also should be undertaken. In this case, that could mean increased use of income tax withholding requirements and electronic payment systems, which are traceable or reportable to third parties.
- Smart use of tax reform, voluntary compliance, and enforcement initiatives. Many countries have large numbers of citizens who do not report all of their income simply because they do not think it is fair to pay perceived high tax rates or respect complex rules around taxes payable. Tax code simplification or reduced official tax rates may produce better tax compliance.
- Security background checks on employees and managers who authorize or receive cash payments. In particular, these checks should look for any past involvement with underground economic activity.
- Offering whistleblower programs. These programs could include possible financial incentives to report on alleged instances of illegal activity.
- Increased efforts to promote an awareness among clients about the risks and consequences of illegal underground economic activities. For example, organizations could publicize instances where enforcement actions have been taken.