How to expose and shrink the 'underground economy'

Donald H. Skadden has an idea for catching tax cheaters: either take $100 bills out of circulation entirely, or let large-denomination bills expire every two years, as the Swiss do.

Mr. Skadden is chairman of a tax-policy-subcommittee task force of the 200, 000-member American Institute of Certified Public Accountants (AICPA). This four-man group has spent part of the past 2 1/2 years dreaming up ways to slow the growth of the ''underground economy'' - the sizable portion of the nation's economic activity, legal or illegal, which does not pay taxes owed.

Estimates of the size of the underground economy vary enormously. The government, however, conservatively estimates it lost $90 billion in unpaid taxes last year because of it. That amounts to about $4,090 per individual. If all that had been collected, most of the federal deficit would have been eliminated.

That's why Mr. Skadden, associate dean at the Graduate School of Business Adminstration, University of Michigan (Ann Arbor), regards the reduction of tax cheating as so vital. ''If we can just change the psychology in the tax-paying public and keep it (the underground economy) from growing and snowballing, that would be an important step,'' he said in a telephone interview. ''There is a serious danger to our self-assessed tax system, which is the best system in the world.''

The AICPA report was timed to come out by the April 15 income-tax deadline, when public attention is focused on taxes. (Other members of the task force were Donald Tannenbaum, John Gilbert, and Rufus Hardy.) Here are some of the group's suggested solutions to the tax-cheating problem:

* Encourage a cashless society.

Currency movements often leave no record. Thus, as the underground economy has grown over the last 10 or 15 years, the amount of large-denomination bills in circulation has skyrocketed. A weekend house painter may get paid in cash. Illegal drug dealers use $100 bills for their transactions.

If $100 bills were abolished, the sheer bulk of cash needed to make a large underground transaction would be awkward. Or, if the big bills were replaced every two years with bills of a different size or color, those possessing the old bills would have to deposit them or exchange them for new bills with banks or some government office. The government could then check whether the money is being reported as income.

* Add questions about money and barter transactions to the 1040 form.

Whenever someone barters a product or service for some other product or service, he should record the transaction at fair-market value for tax purposes. In recent years the barter market has grown rapidly, apparently because many people illegally duck taxes that way. They rationalize this step by saying to themselves that no cash was involved.

''A lot of people, if they saw a question there on the form and had to sign it under penalty of perjury, might not skip taxes on barter deals,'' Mr. Skadden said.

* Retailers and banks should be required to report large currency transactions.

If this suggestion were implemented, when someone paid an auto dealership $10 ,000 in bills to buy a new car, the proprietor would have to report it to the Internal Revenue Service (IRS). Similarly, when customers deposited or withdrew, say, more than, $3,000 or $5,000 in currency, the banks would have to report it.

* Deductions for expenses above a certain amount should not be allowed if they are paid for with currency.

If an independent contractor, a small retailer, or a restaurant owner were to pay a large bill in currency, he would not be allowed to take it as a business-expense deduction. These three types of businesses, according to the IRS, are more often tax cheaters or dealing with tax cheaters than big business is. (Of course, any incorporated business, big or small, would be subject to the rule.)

* Improve the withholding system.

At present, businesses are required to report payments to independent contractors who charge more than $600 for their work. Mr. Skadden's group suggests an appropriate tax also be withheld - say 5 to 10 percent.

The task force also recommends withholding on interest and dividend payments - a matter of great controversy at the moment. However, it suggests a simpler system than that scheduled to go into effect at midyear.

IRS experience shows that once money is withheld, fewer people will neglect to report the income for tax purposes. Some 60 percent of the income of independent businesses is reported; 88 percent of interest and dividends; and 98 .5 percent of salaries and wages on which taxes are withheld.

Of course, some of these task-force suggestions involve additional paperwork and, in a sense, invasions of privacy, which would have to be weighed against their tax-collecting benefits.

One key recommendation of the task force calls for a campaign to alert the tax-paying public to the importance of tax honesty. Government, tax accountants, business, trade associations, and labor unions would be urged to join in the campaign. The public should realize, Mr. Skadden said, that everyone benefits if the tax system works properly.

Another important suggestion is that Congress stop using the tax system for all sorts of purposes, creating deductions to encourage this or that activity. If low- and middle-income people see the tax system as unfair, giving special deductions to the rich, they will ask themselves why they should pay full taxes, Mr. Skadden said - and the underground economy will continue to grow.

Legal tax breaks (Federal tax expenditure for selected years) '75 '77 '79 '81 '82 Totals (in billions of dollars) 92.9 113.5 149.8 228.6 253.5 Tax breaks as a percentage of: Federal outlays 28.5 28.2 30.3 34.6 34.6 Federal revenues 33.1 31.7 32.3 37.9 40.8 GNP 6.3 6.1 6.4 8.0 8.4 GNP (in billions of dollars) 1,479.9 1,864.1 2,417.8 2,937.7 3,033.8 Source: Congressional Budget Office