There are widespread reports of a growing underground, or unobserved, economy in the United States and in other countries. The unobserved economy seems to develop principally from efforts to evade taxes and government regulation. Although no single definition of such activity has been universally accepted, the term generally refers to activity – whether legal or illegal – generating income that either is underreported or not reported at all (see Chapter 1 in this volume). Some authors narrow the definition to cover income produced in legal activity that is not set down in the recorded national income statistics.

Recent discussion of underground economic activity was stimulated by publication of two estimates, one by Gutmann (1977) and the other by Feige (1979), of the size of the underground economy in the United States; these estimates were derived from aggregate monetary statistics. In the ensuing years, numerous other estimates have been made of the underground economy in the United States and in other countries. The magnitude of some of these estimates has prompted congressional hearings and various government studies. In 1979, the Internal Revenue Service (IRS, 1979) estimated that, for 1976, individuals failed to report between $75 billion and $100 billion in income from legal sources and another $25 billion to $35 billion from three types of illegal activity – drugs, gambling, and prostitution. In a more recent study, the IRS estimated that unreported income from legal sources rose from $93.9 billion in 1973 to $249.7 billion in 1981 whereas unreported income from these same three illegal activities rose from $9.3 billion to $34 billion (IRS, 1983).