Rachel Reeves should beware: the black, or hidden, economy is once more on the rise, and it may have something to do with the Chancellor’s own tax demands.
There’s a Thai restaurant near where I live where a sign prominently displayed in the window reads “Cash only, no credit or debit cards”.
At first blush, this would seem curiously counter to the wider trend of restaurants and cafes refusing to accept cash. Notes and coins are expensive to process relative to digital payments, and are also acutely vulnerable to the plague of petty crime.
Dig a little deeper, however, and you find that the cash economy may once more be strongly on the rise.
Hard evidence for this contention is admittedly mixed, even if anecdotally it might seem strong. Fewer people carry cash – but especially for casual work, many more are demanding it.
The Bank of England insists that the amount of physical cash issued follows no particular formula, but in any one year is only an estimate of likely demand.
This might suggest little or no increase in the size of the cash economy. None the less, both the number and value of bank notes in circulation have risen considerably over time despite the explosive growth in digital payments for day-to-day purchases.
Between 2005 and 2017, the value of banknotes in circulation doubled, outstripping the growth in the economy by some margin. Even adjusting for rising economic activity and price levels, notes in circulation have been trending upwards ever since the early 1990s.
The big jump, however, was during the pandemic, when demand for physical cash rose strongly even as economic activity collapsed and scare stories proliferated that the use of bank notes was a key cause of viral infection.
The Bank of England has explained this apparent paradox by pointing to the growing attractions of cash as a store of value at a time of low inflation and rock-bottom interest rates.
But my guess is that there is more to it than that.
Relatively recent survey evidence by HM Revenue & Customs (HMRC) suggested that 8.8pc of UK adults participated in the “hidden” economy, in 2022, well up on the 4.9pc of the previous estimate in 2015 to 2016.
A further 4.8pc of the population were identified as being “possibly involved” in the hidden economy, up from 0.6pc in 2015 to 2016.
Off-the-books use of cash as a means of payment is not solely determined by the amount of cash in circulation either. It’s the velocity of money, rather than its quantity, which determines its economic value. A single £10 note might, for instance, be exchanged multiple times in a day.
More or less everyone will have had some experience of the black economy even if they haven’t themselves participated in it.
Cash is king, many tradesmen will say given the choice between cash and a bank transfer or credit card payment. Generally, the price is lower for cash.
Many of these payments will not be wholly declared for tax purposes. It’s only on very large transactions that cash tends to become impractical and/or hard to hide from the taxman.
Two points are worth making here. One is that if the hidden economy is indeed breaking new ground, it means that the economy as a whole is stronger than the official data suggests.
Rather more worrying for the Government, it also means that a growing proportion of economic activity is escaping the tax net. We may already be seeing this played out in real time as a result of measures in Reeves’s Budget to significantly raise the tax burden.
Tax revenues in January, traditionally a buoyant month because of the deadline for self-assessment, fell significantly short of Office for Budget Responsibility expectations.
Reeves may already be hitting the “Laffer curve” of diminishing returns, particularly among smaller enterprises and the self-employed, whereby higher taxes lead to growing avoidance and evasion.
With personal tax thresholds now frozen until 2027 to 2028, the trend is likely only to get worse.
Self-employed and part-time workers may be choosing to take a greater proportion of what they earn in the form of under-the-counter cash payments. With rising taxes, small and occasional cash earnings are particularly vulnerable to non disclosure.
Nor is it just higher taxes pushing people into the hidden economy. Pressure on disposable incomes from the cost of living crisis further increases the incentives to demand tax-free cash payment for goods and services.
A House of Commons public accounts committee report back in 2020 found that the Bank of England did not “appear to have a convincing reason for why the demand for notes keeps increasing” or any real understanding of where approximately £50bn of issued sterling notes are, or what they are being used for.
Worry not, says HMRC. The so-called “tax gap” – the difference between what HMRC thinks should be paid in tax and what is actually being paid – has been in steady decline for years. At the last estimate, it stood at 4.8pc, or £39.8bn, of what should have been collected.
This would not suggest a growing black economy. Maybe, but given what I see happening all around me, and the manifestly growing incentives for tax-dodging, I remain to be convinced.
As on so much else, we’re plunging back to the “fallen off the back of a lorry” economy of the 1970s and the early 1980s, where tax avoidance and evasion was the name of the game.
This was the unofficial economy of Arthur Daley and Only Fools and Horses. If you tax too much, don’t be surprised when you hit a brick wall of refusal to pay.
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