The Underground Federal Government: Bane of the Balanced Budget?

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In recent years both academics and the popular presshave shown a growing interest in the "underground economy" --the volume of transactions that involve payment in money orin 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 privateeconomy is perhaps the ultimate stage of the "tax revolt ofthe '70s." Numerous constitutional and statutory limitationswere 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 accumulatewealth (or to just break even) have induced American taxpayersto conceal literally hundreds of billions of dollars from thepurview of the tax collector. Some of the policy implicationsof the recent excavations of the underground private economyare both powerful and straightforward: We have grossly under-stated actual levels of employment, income, output, savings,and productivity, which renders various "stimulative" spendingpolicies misdirected at best. The economy may be far healthierthan generally believed.

Much of the writing and research on the tax revolt ofthe 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 involvesthe question of how politicians, who are, of course, everybit as calculating as the ordinary citizen, have responded torecently imposed constraints on their abilities to accumulatewealth and power through the political process.In general, for nearly a century state and local governmentshave responded to various taxpayer revolts and the accompanying spending, taxing, and borrowing limitations by giving lipservice to fiscal responsibility while simultaneously creatingscores of "off-budget enterprises" (OBEs) through which theycan conduct "business as usual." Taxpayer demands for fiscalresponsibility have also spawned the growth of the off-budgetactivities 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 examinesthe 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.

James T. Bennett and Thomas J. DiLorenzo

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.