Around 10% of the UK economy operates off the books. That means billions of pounds worth of cash-in-hand payments that never get taxed.
Authors
- Danny Buckley
Director of Studies, Loughborough University
- Natalia Vershinina
Professor of Entrepreneurship, Audencia
But all of that cash isn’t necessarily being handled by career criminals. Much of it is being earned by the hard work of painters and decorators, hairdressers or landscape gardeners.
Many of these workers will have started off using cash payments as a springboard – a cheap, low-risk way to test whether a business idea works before committing to the formalities (and costs) of making everything official.
But sometimes these businesses end up trapped in the “informal” or “hidden” economy – not because of personal greed or an aversion to paying tax, but because they can’t afford to lose the customers that helped them get started in the first place.
Our research highlighted the problems workers face as they set out intending to build a fully legal and legitimate tax-paying business.
Many cash-in-hand businesses win their first customers – who may be supportive neighbours or friends – by being cheap. Working in cash, without the tax and overheads a registered business has to carry, they can undercut everyone else.
Those prices then become expected and lead to word-of-mouth recommendations. As one self-employed plasterer told us: “At the start I kept the price low just to get work, to build it up. But now people expect that [same] price.
“If I raise it, they’ll go somewhere else. It’s hard to change it once you’re known for being cheap.”
A heating engineer commented: “Initially, I did build a good customer base, but now I know [it was] because I was so cheap. I wasn’t accounting for tax and all that.”
Trust and reputation can grow by being a familiar, reliable face in the neighbourhood. As one painter and decorator explained: “I didn’t need a website or anything. People know me around here, they knew I’d do a good job. That’s how I got work, just word of mouth. That’s all I needed.”
A cash-in-hand economy runs on trust, reputation and identity – which is precisely why lots of businesses don’t manage to leave it behind.
Becoming an “official” business can feel like breaking faith with the people who vouched for you, or like turning into a business you never set out to run. This became problematic for a lot of the businesses in our study.
As one business owner who works in car repairs put it: “People know you because you’re one of them. Once you try and go bigger, that changes.”
Some of our interviewees saw the formal system as having been built for someone else. One told us: “I’ve seen lads go legit and get hammered by the tax man for one [accounting] mistake. I don’t trust it. I pay my dues in other ways – doing good work, looking after the lads I work with. That’s how we survive.”
Regardless of the rationale for operating in the cash-in-hand economy, staying informal was not seen as a comfortable or easy choice.
One business owner who eventually registered described life off the books as being “on edge all the time”. But for most, the pull of the community outweighed the push of the risk.
Their legitimacy came from their neighbours, not from HMRC, and they protected the version that paid them.
Trust and identity
Government policy treats going legitimate as an administrative step , but our research suggests it is actually more of a social transition. It asks the business owner to reprice every relationship they have, and to change who they are in their community. Support schemes that ignore this will keep failing.
If it takes a village to raise a child, something similar is true of small businesses. The first customers, the word-of-mouth referrals, the neighbour who vouches for you all help a new business get going. But the same village which has raised that business can also hold it back.
The UK government estimates the hidden economy accounts for around 6% of the country’s £59.2 billion annual tax gap.
Our research points to two things that could make a big difference. One would be a phased route into formality, where tax and compliance obligations build up gradually, softening the income shock that all-or-nothing registration creates.
Secondly, support needs to reach people through channels they already trust, such as trade networks, suppliers and peers, rather than official letters from institutions they avoid.
Leaving the cash economy is much more than a change of paperwork – it is a change of identity. And that is why so few ever fully make it.
