Why the Informal Economy is Rising in America

The official unemployment is near 5%. However, the official unemployment rate is only this low due to those who report that they are not seeking work or no longer qualify for unemployment.

Yet there are no massive encampments of starving people, no million man marches of those demanding work, no hordes of desperate Americans driving out 3-10 million illegal aliens ostensibly here to work in the hope of getting their jobs. Where did the millions of unemployed people go, if they are not all at home on welfare, disability benefits or food stamps?

How are those millions who are unemployed managing to survive if unemployment and social benefits are not enough? Many have moved to the informal economy, also called the underground economy or System D.

There are several million illegal immigrants in the United States. Estimates range from three to thirteen million. Those who came to work here illegally sometimes gain the right to work legally, but they have little incentive to do so. After all, working legally requires paying taxes and losing welfare benefits like free lunches and WIC for American born children. Reporting one person’s income while hiding another adult’s income allows them to collect the Earned Income Tax Credit or EITC. It pays better to work at least partially if not entirely off the books, even when they can do so legally.

The informal economy has been further driven by the illegal immigrant subculture. Why work on the books and in the formal economy, when your parents made a good living working in the informal economy? Children of immigrants can choose to work as their parents did, off the books while making a living, while retaining any social welfare benefits they receive due to low or no reported income.

For those managing to get by, seeing those making the same or somewhat lower wages but receiving more take home pay due to tax avoidance makes working in the formal economy seem foolish. Where illegal aliens have created a whole hidden job market from day labor centers to factories that pay workers in cash, citizens easily move into the informal economy to make a living.

Increased regulation makes formal employment become informal employment when the person has no other employment options. The woman who watched children from her home as a registered childcare provider may not be able to pay for the additional fees, increased licensing fees and restrictive mandates pushed by day care centers. Yet this is a way to pay the rent or stay at home with her own children. Instead of ceasing what she was doing, she simply stops reporting herself as a childcare provider. She then continues to provide care and receive payment, but she no longer pays the official fees or taxes. Home based craft businesses faced the same challenge when product testing was mandated due to the rash of lead and cadmium tainted Chinese made toys and baby items. Instead of shutting down, they simply stopped existing legally while continuing to sell at flea markets, craft fairs and online.

High employment taxes and benefit mandates make it too expensive to retain as many formal employees. Businesses then shift to the informal sector, hiring through day labor centers or hiring centers that pay off the books or don’t pay benefits. This in turn drives more workers to the informal job market, because there are fewer positions in the formal sector and lower paying informal work is better than no work.