America's Underground Economy: Measuring the Size, Growth and Determinants of Income Tax Evasion in the U.S

Abstract

This study empirically investigates the extent of noncompliance with the tax code and examines the determinants of federal income tax evasion in the U.S. Employing a refined version of Feige’s (1986; 1989) General Currency Ratio (GCR) model to estimate a time series of unreported income as our measure of tax evasion, we find that 18-23% of total reportable income may not properly be reported to the IRS. This gives rise to a 2009 “tax gap” in the range of $390-$537 billion. As regards the determinants of tax noncompliance, we find that federal income tax evasion is an increasing function of the average effective federal income tax rate, the unemployment rate, the nominal interest rate, and per capita real GDP, and a decreasing function of the IRS audit rate. Despite important refinements of the traditional currency ratio approach for estimating the aggregate size and growth of unreported economies, we conclude that the sensitivity of the results to different benchmarks, imperfect data sources and alternative specifying assumptions precludes obtaining results of sufficient accuracy and reliability to serve as effective policy guides

Keywords: Unreported economy; Underground economy; tax evasion; tax gap; noncompliance; income tax evasion; currency demand approach, currency ratio models

JEL Classification: E26; H26; O17; E41; E52