Wednesday, March 20, 2013

Obama Finally Brings Growth — To the Shadow Economy

Obama Finally Brings Growth — To the Shadow Economy:
Stack of cashIf as many Spaniards were out of work as official
figures suggest,
pointed out
Victor Mallet and Guy Dinmore in a 2011 article in
the Financial Times, "Spain would not be as peaceful as,
barring a few demonstrations, it has so far been." Spain's
unemployment rate has gone up since then, and while the country
isn't exactly thriving, there's no rioting or mass starvation,
either. Clearly, there's a huge gap between official data and what
people are actually doing, and occupying that gap, they reported,
are off-the-books jobs, untaxed businesses and lots of cash in an
active shadow economy. As
noted at Reason 24/7
, Rick Newman of U.S. News & World
has spotted a similar mismatch — this time in the
United States. Income isn't rising. Neither, really, is credit-card
debt. But consumer spending is marching along at a healthy clip.
Once again, unofficial economic activity beyond the reach of tax
collectors and regulators seems to be taking up the slack.

Writes Newman
Household spending has held up surprisingly well in recent
months, even though new taxes have reduced paychecks and other
problems are holding back the economy. Incomes haven't risen by
nearly enough to explain the entire boost in spending. Nor has the
use of credit cards.
When your teenager starts wearing expensive clothes and flashing
bling he couldn't possibly afford through his part-time job, you
start to wonder where the money is coming from. Some economists are
asking the same question about consumers who seem more flush than
they ought to be. The answer may lie in the large "underground"
economy that doesn't show up in official statistics.
He goes on to cite Bernard Baumohl of the Economic Outlook
Group, who
recently wrote
[S]evere recessions have historically driven jobless
Americans into the shadow economy, and we suspect the destructive
nature of the last downturn and the prolonged weak recovery pushed
a record number of people into that murky world of cash
transactions. Doing so allows them to earn money without reporting
their income, leaving more available to spend. ...
Despite the sharp drop off in the labor force
participation rate, consumer spending has nevertheless continued to
surge. One explanation is that many of those who have left the
labor force since the last recession have managed to earn income in
the shadow economy and their spending still shows up in the
official retail sales and personal consumption data.
Adds Newman:
That may help explain one troubling trend—a sharp
decline in the labor-force participation rate, which measures the
percentage of the adult population considered to be either employed
or looking for work. The participation rate has dropped from a peak
of 67.3 percent in 2001 to 63.5 percent today. The last time it was
that low was 1979. Some economists think this reflects a worn-out
workforce resigned to long-term decline. But it might show a
migration of workers from the official economy to the underground
one instead.
There's always a bit of a data lag, but income figures haven't
looked good for several years. In September 2012, the Census Bureau

that "[r]eal median household income in the United
States in 2011 was $50,054, a 1.5 percent decline from the 2010
median and the second consecutive annual drop." Household income is
down 5.7 percent
since the "recovery" began, Sentier Research
reported that same month.
And let's not forget that lovely New Year's gift we all got in
the form of a
payroll tax hike
And yet ... consumer spending has been rising. Retail
sales were up 1.1 percent in February. Even if you leave out car
purchases and the big jump in gasoline prices, reports the
Los Angeles Times
, "so-called core retail sales
increased a solid 0.4% in February, and this measure was revised up
to 0.3% for January from 0.1% previously estimated."
Or as the federal Bureau of Economic Analysis puts
Personal income decreased $505.5 billion, or 3.6 percent, and
disposable personal income (DPI) decreased $491.4 billion, or 4.0
percent, in January, according to the Bureau of Economic Analysis.
Personal consumption expenditures (PCE) increased $18.2 billion, or
0.2 percent. In December, personal income increased $353.4 billion,
or 2.6 percent, DPI increased $325.7 billion, or 2.7 percent, and
PCE increased $14.8 billion, or 0.1 percent, based on revised
Real disposable income decreased 4.0 percent in January, in
contrast to an increase of 2.7 percent in December. Real PCE
increased 0.1 percent, the same increase as in December.
But, this is America. So, we're all running up the credit cards,
right? Except, we're not. While overall consumer debt is moving,
revolving credit — the interest-laden purchases we put on plastic —
is barely budging. According to the Board of
Governors of the Federal Reserve Bank
, revolving credit was up
all of 0.1 percent in January, and down 4.4 percent in
December. So Americans aren't running up unsecured debt in a crazed
spending spree.
But, Americans are spending something.
Newman's theory about a growing shadow economy makes a lot of
sense. That's a very interesting development, because the United
States has traditionally had a very small shadow economy
relative to other developed nations. The most
recent estimate
from Professor Friedrich Schneider of the
University of Linz puts the U.S. shadow economy at 7.2 percent,
compared to Switzerland at 8.2 percent, with percentages going up
from there. Given the divergence between official figures and
consumer activity, that 7.2 percent figure may not hold
And the thing is, once people slip into the shadows, it's hard
to get them back. Writes
But even major tax reforms with major tax rate deductions will
not lead to a substantial decrease of the shadow economy. Such
reforms will only be able to stabilize the size of the shadow
economy and avoid a further increase. Social networks and personal
relationships, the high profit from irregular activities and
associated investments in real and human capital are strong ties
which prevent people from transferring to the official economy.
Once people get used to operating in the shadows, not paying
taxes, using cash, dodging paperwork, it becomes increasingly
difficult — and unattractive — for them to come back
After years of conservative accusations that the Obama
administration is trying to turn the United States into Europe,
that charge may actually be coming true. We just didn't know that
the model for the transformation was Spain's crisis-fueled
underground economy.
I wrote at length about tax collection and the shadow economy