This volume explores the nature, meaning, measurement, and implications of the still largely uncharted domain of economic activity that has come to be known by the popular catchphrase the “underground economy.” It is generally thought to consist of those economic activities and the incomes derived from them that circumvent or otherwise elude government regulation, taxation, or observation. This is a subject that arouses great curiosity, many anecdotes, and few admissions of involvement. The term has been used to cover a wide range of economic activities including but not limited to the traffic in drugs, prostitution, pornography, gambling, “off-the-books” employment, “skimming,” “moonlighting,” and tax evasion. What these disparate activities appear to have in common is the penchant of those who engage in them to conceal them from government and public scrutiny.

Public attention was drawn to the underground economy during World War II when higher tax rates, price controls, and rationing programs provided incentives for firms and individuals to participate in various “black market” activities. Black market transactions were typically effected by cash payments in order to eliminate a ready audit trail that could otherwise be used by tax authorities and other regulatory agencies for enforcement purposes. A major form of tax evasion was underreporting income to the Internal Revenue Service (IRS).

Although anecdotal evidence of black market activities and tax evasion were widespread, it was left to Cagan (1958) to devise a simple currency ratio method for obtaining a rough quantitative measure of the size of unreported income.