The GDP residual error and the black economy: a note

In recent years, the ''black economy'' has been the topic of much speculation. One of the many signs of a rising black economy can be found in the gross domestic product (GDP) residual error. The contention is that unrecorded economic activity will create underestimates of the income-based measure of GDP, but because some of this income will be spent, it will be recorded in the expenditure estimate of GDP. Thus, a rise in the black economy would coincide with a rise in the residual discrepancy. A simplified model for an aggregate economy is used to provide substance for this claim. A significant statistical relationship is found between the initial residual difference (the residual error between the expenditure and income estimates of GDP) and the average tax rate. This suggests that the residual difference does reflect movements in the black economy.