Cash-in-hand work is often portrayed as a deliberate choice: stay off the books, undercut registered competitors, and keep the tax authorities out of the picture. New research from Loughborough University tells a more complicated story. HM Revenue & Customs (HMRC) estimates that £59.2 billion in UK tax went unpaid in 2024/25 — equivalent to 6.4% of all tax theoretically due. Around 6% of that shortfall, roughly £3.6 billion, is attributed to the “hidden economy”: economic activity that is entirely undeclared to the tax authorities.
The study, led by Dr Danny Buckley of Loughborough Business School, found that most business owners who work cash-in-hand started out with every intention of becoming legitimate. Informality was meant to be a temporary bridge — a way to test a business idea before committing to the costs of formal company ownership. Instead, many found themselves locked into informal business models they could not sustain, and none of the participants made a clean transition to full formality.
For aspiring entrepreneurs, small business owners, advisers and policymakers, these findings carry an important message: the path from informal to formal trading is far harder than it looks, and the timing of support matters more than the threat of penalties. Have questions about how this research applies to your own situation? Share your thoughts in the comments below or explore our related articles on starting and running a compliant small business.
The Hidden Economy and the UK Tax Gap: What the Numbers Show
The UK tax gap — the difference between tax owed and tax actually collected — reached £59.2 billion in 2024/25. HMRC attributes this gap to several causes, including error, evasion, criminal attacks and legal avoidance. The hidden economy accounts for roughly 6% of the total, or around £3.6 billion in unpaid tax each year.
That figure understates the wider economic significance of informal work. Cash-in-hand and other undeclared activity is estimated to represent around 10.5% of UK GDP. In practical terms, a significant slice of the country’s economic output — much of it in everyday services such as building work, hairdressing, car repairs, landscaping and electrical jobs — never enters the tax system at all.
Policy responses have historically followed a straightforward logic: if people work informally to avoid tax, then detection, penalties and fines should push them back into the formal economy. Registration has also been simplified over the years, on the assumption that administrative friction is the main barrier. The Loughborough University study suggests that both assumptions miss the mark for a large share of informal businesses.
Why Businesses Start Out Working Cash-in-Hand
Researchers interviewed business owners across the East Midlands, working in sectors where informal trading is common: construction, plumbing, hairdressing, car repairs, landscaping and electrical work. Rather than finding calculated tax dodgers, the study found people who described cash-in-hand work as a provisional and strategic starting point.
For many, going informal was a way to test whether a business idea could succeed without immediately taking on the costs and risks of formal company ownership. Registering a business brings obligations: bookkeeping, tax returns, National Insurance, accounting fees, insurance and compliance costs. Working cash-in-hand allowed these entrepreneurs to build up money, establish customer demand and find out whether their trade could support them — all before committing to that overhead.
Crucially, every participant said that at some point they intended to become fully formal. The problem was not willingness. It was that the advantages of informality quietly turned into obstacles that made formality unaffordable, unattractive or practically impossible.
Three Forces That Trap Informal Businesses
The research identified three interlocking forces that keep entrepreneurs stuck in the cash-in-hand economy. Understanding them is essential for anyone advising small businesses — or planning to start one.
1. Pricing Routines That Harden Into Customer Expectations
Informal businesses can initially offer cheaper services because they are not accounting for tax, insurance or administrative costs. Customers quickly become accustomed to those lower prices. When the owner later tries to formalize, prices must rise to cover the new obligations — and customers resist. What began as a competitive edge becomes a ceiling: the business cannot raise prices enough to absorb formal costs without losing the customer base it built on cheap rates.
2. Local Legitimacy Built on Relationships, Not Credentials
In many communities, work comes through trust and reputation rather than formal qualifications. Being known locally — through word of mouth among neighbours, friends and repeat customers — generates a steady flow of jobs. Going official risks breaking faith with the very people who vouched for the business in its early days. Some owners feared that charging more, or operating in a more formal capacity, would damage the personal relationships their customer base depended on.
3. Administrative Capability Gaps
With one exception, none of the study’s participants had business education beyond their technical trade skills. They could plumb a bathroom, rewire a house or cut hair expertly, but pricing for profit, managing cash flow, keeping books and handling tax returns were unfamiliar territory. Without these administrative capabilities, the leap to formality felt risky and unmanageable — so it kept being postponed.
Taken together, these forces created what the researchers describe as a form of entrapment. Most participants were left running informal business models they could not sustain long-term, yet could not escape. Readers who want the full detail can explore the paper, “From opportunity to entrapment: path dependency of informal enterprise,” published in the International Journal of Entrepreneurial Behavior & Research.
Why Detection and Penalties Alone Will Not Close the Tax Gap
“The common assumption is that cash-in-hand businesses are making a straightforward calculation: stay off the books, pay less tax. Policy has largely followed that logic, leaning on detection, penalties and fines to push businesses into the formal economy,” said Dr Buckley.
The research challenges that framing. If most informal traders actually want to become legitimate but cannot afford to do so — because of entrenched pricing, community expectations and capability gaps — then enforcement alone addresses only a fraction of the problem. Heavier penalties may even push marginal businesses further underground rather than prompting conversion.
The same applies to simplifying registration. Making it easier to register and pay tax removes one barrier, but the study shows the decisive barriers lie elsewhere: in the economics of the business model itself. A business whose prices were set without tax in mind cannot simply absorb a new tax bill by registering; it needs a viable plan for repricing, repositioning and rebuilding customer expectations.
Practical Lessons for Entrepreneurs and Small Business Owners
For anyone starting or running a small business, the findings translate into concrete, actionable advice:
- Price for the full cost of formality from day one. Build tax, insurance and administrative costs into your prices before you win your first customer. It is far easier to set sustainable prices at the start than to raise them later against entrenched expectations.
- Formalize early, even in a small way. Registering as a sole trader is relatively simple and inexpensive. Doing so from the outset prevents the pricing and trust traps from forming in the first place.
- Invest in business administration skills. Technical skill wins work, but pricing, cash flow management and bookkeeping keep a business alive. Short courses, online training and local enterprise support can close these gaps quickly.
- Treat informal trading as a last resort, not a launch pad. If you need to test demand, consider low-cost formal options first, such as starting part-time alongside employment, so compliance costs stay manageable while you validate the idea.
- Communicate value beyond price. Competing on being the cheapest cash option is a fragile position. Building a reputation on quality, reliability and proper documentation protects you when prices must rise.
If you are considering starting a business, schedule a free consultation with a local business adviser or growth hub before you set your prices. Getting pricing, cash flow and compliance right at the earliest stage is the single most effective way to avoid the traps this research identified.
What Needs to Change: Support Before Informality Takes Hold
Dr Buckley’s conclusion is clear: tackling informal work requires more than enforcement or simplified registration. “Support should reach entrepreneurs before informal practices like this become embedded,” he said. “They need help understanding pricing, cash flow and business administration from the earliest stages of setting up a business.”
In practice, that points to earlier and more targeted intervention: business skills support bundled into the first months of trading, outreach in the trades and communities where informality is most common, and advisers equipped to help owners reprice and reposition when they are ready to formalize. It also suggests a stronger role for enterprise education — ensuring that skilled tradespeople receive business training alongside their technical qualifications.
For business support organizations and policymakers, the message is equally direct: help that arrives after a business is embedded in informality comes too late. Prevention, delivered at the point of business formation, is where intervention is most effective. If your organization works with small businesses, explore how early-stage pricing and cash flow support could be built into your offer.
The Wider Picture: Informal Business and the UK Economy
The cash-in-hand economy is not a marginal curiosity. With undeclared work estimated at around 10.5% of UK GDP and the hidden economy contributing roughly £3.6 billion to unpaid UK tax annually, the stakes for individuals, honest competitors and public services alike are substantial. Registered businesses that pay their taxes face unfair competition from informal rivals; public services lose revenue; and informal traders themselves often end up with businesses that cannot scale, secure finance or survive setbacks.
What makes the Loughborough University research valuable is that it reframes the problem. Informality is less a moral failing to be punished and more a structural trap to be prevented. Entrepreneurs fall into it through reasonable, short-term decisions that compound into long-term constraints. That reframing changes the solution: from chasing and penalizing informal traders to equipping new business owners with the pricing knowledge, administrative skills and confidence to start formal — and stay formal.
Final Thoughts
The billions in unpaid tax linked to cash-in-hand work will not be recovered through fines alone. As this study demonstrates, most informal traders never planned to stay off the books; they planned to formalize and found that early choices — on pricing, on community relationships, on skills — had quietly closed that door. The remedy lies earlier in the journey: better business education, earlier support and pricing that accounts for the true cost of legitimacy from day one.
Have you worked cash-in-hand, or made the transition to formal trading? Share your experiences in the comments below — your story could help other entrepreneurs avoid the same traps. And if you found this analysis useful, explore our related articles on small business finance, tax compliance and starting a business the right way.
