Policy Analysis No. 19

The Underground Federal Government: Bane of the Balanced Budget?

By James T. Bennett and Thomas J. DiLorenzo
October 21, 1982

Executive Summary

In recent years both academics and the popular press have shown a growing interest in the “underground economy” — the volume of transactions that involve payment in money or in other goods (barter) but which are not recorded in official statistics. The transactions may not be recorded because they are illegal, such as narcotics and prostitution, or because taxpayers simply refuse to pay in full their ever-increasing tax bills. The growth of the underground private economy is perhaps the ultimate stage of the “tax revolt of the ’70s.” Numerous constitutional and statutory limitations were imposed on state and local government taxing and spending powers, and 31 state legislatures voted to convene a convention to adopt a balanced budget amendment to the U.S. Constitution.

Tax-imposed constraints on one’s ability to accumulate wealth (or to just break even) have induced American taxpayers to conceal literally hundreds of billions of dollars from the purview of the tax collector. Some of the policy implications of the recent excavations of the underground private economy are both powerful and straightforward: We have grossly under-stated actual levels of employment, income, output, savings, and productivity, which renders various “stimulative” spending policies misdirected at best. The economy may be far healthier than generally believed.

Much of the writing and research on the tax revolt of the 1970s has focused on the “first stage” of the revolt — Proposition 13-type tax limitations — and the second stage — growth of the underground economy. There is a third stage, however, that has received much less attention. It involves the question of how politicians, who are, of course, every bit as calculating as the ordinary citizen, have responded to recently imposed constraints on their abilities to accumulate wealth and power through the political process. In general, for nearly a century state and local governments have responded to various taxpayer revolts and the accompanying spending, taxing, and borrowing limitations by giving lip service to fiscal responsibility while simultaneously creating scores of “off-budget enterprises” (OBEs) through which they can conduct “business as usual.” Taxpayer demands for fiscal responsibility have also spawned the growth of the off-budget activities of the federal government. In short, just as tax-imposed constraints on individual incomes have created a burgeoning underground private economy, taxpayer-induced constraints on the politician’s ability to parlay the public sector to his personal advantage, at taxpayer expense, have generated the growth of an “underground government” at all levels. Thus, the size and influence of the public sector of the economy is much larger than generally believed. This paper examines the activities of the underground federal government in particular, and discusses the implications of “off-the-books” government activity for efforts to secure a balanced-budget amendment.

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James T. Bennett is Professor of Political Economy and Public Policy, and Thomas J. DiLorenzo is Assistant Professor of Economics, George Mason University, Fairfax, Virginia.