An Empirical Note on Tax Auditing and the Size of the Underground Economy in the United States, 1962-1980

Based on the empirical estimation in this study, for the period 1962-1980, it appears that the underground economy in the United States was sensitive to the federal personal income tax rate, inflation, and the percentage of filed tax returns audited by the IRS. Presumably, the problem associated with inflation has been largely addressed by the inflation-indexing provisions of the Tax Reform Act of 1986. Regarding federal personal income taxation, the relative size of the underground economy could presumably have been diminished by a lower effective tax rate. Furthermore, a more aggressive tax auditing policy might also have induced increased reporting of earned income.