The moral and practical dilemmas of an underground economy.

• Author: Epstein, Richard A.
• Position: Symposium: The Informal Economy

Richard Epstein explores the relationship between one's approach to the underground economy and one's belief about what conduct should be legal. He discusses the link between people k views of a law's fairness and their ropensity to obey the law, noting that if those who bear the law's burdens view it as unfair the fabric of voluntary compliance will unravel Epstein surveys six case studies of the underground economy: public streets and sidewalks; eaglefeathers and elephant tusks; pollution regulation; taxation; rent control and minimum wage laws; and illegal drugs.

All sorts of activities, some desirable and some unsavory, are part of the underground economy. The physician who takes cash for a Saturday office visit is working off the books; so is the waiter who reports some but not all tips as income; so too is the maid who pays no taxes on her wages. But the underground economy is far more vast than these examples suggest, for it embraces much more than the unreported, unrecorded, or informal economy.(1) It includes industries that rely on illegal aliens and businesses that are completely outlawed, such as the trade in narcotic drugs. Indeed the trade in medicinal drugs belongs on the list, for medicines that are banned in the United States but licensed overseas are doubtless smuggled into this country for use by desperate patients. Surely one could multiply this list of examples many times over.

This Essay will not, however, try to describe the scope of the underground economy or the kinds of activities that compose it. Both topics raise empirical questions better left to specialists. Instead, this Essay will confront two questions. The first, addressed in Part I, is normative: Is an underground economy good or bad, and why? The second question, discussed in Part II, is a combination of normative and descriptive: Are the legal prohibitions on specific underground activities counterproductive? To understand how approaches to the underground economy work in practice, we must supplement our basic normative intuitions with concrete examples.

1. THE NORMATIVE DIMENSION

   1. A Parasitic Question

      The normative question has no easy answer. As the heterogeneous list of examples above indicates, a great deal depends on what activities are being driven underground and why. Furthermore, one needs some critical distance from the current legal system to ask the question. If one thought that all of our current laws were just and appropriate, one would have to condemn the underground economy as an unfortunate result of imperfect law enforcement. It is precisely because there is some tension between the world as it is and the world as it ought to be that the question--What, if anything, should we do about the underground economy?--has any bite at all. The underground economy is a challenge to the legal order by those who refuse to obey its commands. The simple but persistent question is: What alternative to the status quo should we consider? One path asks whether further coercion is required to make violators comply with the law.(2) The other path asks whether it is best to relax the norms, so that activities now underground will rise to the surface and receive the protection of the law.

      There can be no uniform answer to these questions, for everything depends on which underground activity is the focus of attention. To proceed, we must set forth our initial assumptions about what conduct is right and wrong. The more laws there are on the books, the more people will deviate from them and the larger the underground economy will be. Allow free trade in ivory tusks, and there will no longer be an underground economy in the sale of ivory. Allow racetrack betting, and the bookie business will become respectable. Repeal a minimum-wage or maximum-hours law, and sweatshops will come out into the open. Legalize immigration (surely a related issue), and the Haitians and Mexicans will walk proudly through the front door instead of sneaking in through the back.

      It would be a mistake, however, to assume that the way to eliminate the underground economy is simply to remove all legal prohibitions. The suggestion is a little like abolishing the institution of marriage in order to eliminate adultery. A world in which all conduct was legalized would not be a world in which all persons had equal liberty to pursue their private ends. Violence and fraud would reign in a lawless world, and human flourishing would likely be stunted if not destroyed. Uneasiness about the underground economy does not go so far that we are prepared to improve the operation of the market for hit men by enforcing their contracts in open court. Nor should we repeal all laws against toxic dumping so that midnight dumpers can freely pollute the nation's water supply. Nor would most people advocate state enforcement of cartel agreements to spare cartel members the cost of concealing their activities or rigging their markets.

      None of these examples of liberalization looks particularly attractive; the choice of illustrations gives clues to the reasons why. The appropriate response to the underground economy depends upon what conduct should be illegal. But the issue is complex, because there is far more to the inquiry than a categorical distinction between legal and illegal conduct. There is also the broad range of questions about whether legal conduct should be subject to taxes or regulations so onerous that they drive the activity underground. To take a position on the underground economy, one must consider these intermediate positions as well.

      At this point the discussion of the novel issues of the underground economy veers back into familiar paths. Answer first the fundamental questions of

      normative right and wrong, and the attitudes toward the underground economy come much more sharply into focus. My view of the size and scope of government activities deviates sharply from the outlooks and philosophies that dominate modern systems of government and regulation.(3) I do not believe that a just society is one that has no coercive laws. I do think that the prohibition against force and fraud is the central component of a just order. The classical social contract theorists, although wrong about many details, understood the basic trade-off that marks the movement from a state of nature to a civil society: each person renounces his right to use force in exchange for a like promise from all other persons. Parallel arguments apply to fraud and defamation.

      The verb "renounce" makes it appear as if each citizen accepts a single definitive set of terms, in much the same way that each person who buys a condominium or a share of stock accepts the rules of association or incorporation set out by the promoter. The social contract, however, is not a voluntary arrangement but a heuristic device. What drives the model is the confidence that each person who is forced to enter into this arrangement winds up better off, because he values his own life far more than the ostensible right to take the life of another individual. For these purposes, the law of restitution or quasi-contract offers a far better home for social contract theory than does the law of contract pure and simple. A system of collective coercion is therefore necessary to determine that portion of natural liberty that each person is required to surrender and to set the rights that each receives in exchange. Taxation and regulation are surely appropriate to enforce the basic deal: that is, to raise the revenues to organize police, defense, and courts. Yet even after the law imposes these modest limits upon absolute autonomy for all persons, the remaining area of liberty is vast indeed.

      A society of this sort has a strong system of tort law, and its most important component is that which we take for granted: the cardinal sin is deliberate trespass against the person or property of another. A second-tier norm prohibits people from using force to impede business or personal relations. The one difficult issue under this system is the treatment of contracts in restraint of trade. The best response to this problem is not to create either public or private rights of action against the wrongdoer, but rather to rely on public unwillingness to enforce these contracts, which will therefore collapse under their own weight. The set of rules necessary to support these legal institutions of tort and contract are not trivial. Tort covers pollution, and rules that regulate or tax the discharge or transportation of toxic substances may be appropriate, indeed necessary, where private rights of action are cumbersome and uncertain. Similarly, contract covers all forms of property and labor. The law often needs contractual formalities to prevent fraud or misunderstanding. And recordation is often desirable to prevent various forms of double-dealing that could otherwise undermine the security of transactions. No one should suppose that the laws necessary to regulate these arrangements are short or altogether simple. But they would be far simpler than they have become if the law focused on these two major goals: preventing aggression through tort law, and facilitating gains from trade through contract law.(4)

      This world view leads to a massive contraction in the role of the state, and, as noted, makes the question of policing the underground economy far less intractable than it is in the status quo. This approach does not, however, answer all questions. The problems are twofold. First, the model of the minimal state does not speak clearly to the question of whether certain forms of conduct (e.g., prostitution or drugs) should be legal or illegal and, if legal, whether they should be taxed or regulated. Even the so-called minimal state is far removed from no state at all. Second, we do not write on a clean slate. We must make decisions in the context of ongoing government programs and concerns which cannot be easily changed or ignored. For...