Ed Balls has come under fire for suggesting people should get a written receipt for all transactions, even small gardening jobs.
The shadow chancellor said he always asked for a written record, even if it was just for £10 to cut a hedge, because it was the "right thing to do".
Work and Pensions Secretary Iain Duncan Smith said this was "absurd" and showed Labour did not understand business.
He added he did not think anyone in the country would do such a thing.
On Sunday Mr Balls told BBC Radio 5's Pienaar's Politics that people should ask for a record of paying somebody, even if it was for small jobs like cutting a hedge, because they have a "legal obligation" to pay tax.
But Mr Duncan Smith told BBC Breakfast Mr Balls's comments demonstrated "Labour's complete lack of understanding of how business works and how people get by".
Analysis, by personal finance correspondent Ian Pollock
Cash payments are not dirty. In case you had gained the opposite impression, paying a self-employed person in cash for doing a job around your house or garden is completely legal.
Furthermore there is no legal obligation on you to keep a record of the payment, or to account for it to anyone at all. It is your money and you can do what you like with it.
All UK tax obligations lie with the self-employed person you are paying. As a matter of fact, a tradesman is not obliged to even offer you a receipt.
But they should keep proper records so they can pay the right income tax and pay VAT too, if applicable.
Of course, everyone knows that some tradesmen prefer cash because it is hard to trace.
That makes it easier for them to dodge their own tax obligations, if they so choose.
But so long as you have not colluded with them, there is no onus on you to do anything about it. You aren't even obliged to grass them up, though HMRC would like you to do so.
He added: "Here we have a man that would be the chancellor who is wandering around saying Big Brother is going to watch you carefully, that if you do any cash transactions and don't keep receipts, somehow they are going to punish you. I find that absurd."
And Mr Balls's colleague, shadow business secretary Chuka Umunna, also said he did not think most people would keep a receipt for such things.
He told BBC Breakfast: "I don't think everybody will keep a receipt..I don't necessarily keep a receipt for everything I pay for though it's a good idea to keep a record."
The shadow chancellor's comments were made as Labour and the Tories continue to row over alleged tax dodging in light of the HSBC tax scandal.
Pressed on the issue Mr Balls said: "It's not your job to pay their taxes for them and I think most people you give a tenner to are not going to be VAT-registered.
"They've got the legal obligation to make sure they pay their taxes if it's that kind of transaction - but I think the sensible thing for anybody is that you've got a record of it and you've done it properly."
Mr Balls had been "extremely careful" about observing such rules ever since entering politics, he explained.
'Lack of understanding'
Backbench Conservative MP Peter Bone, appearing on the same programme on Sunday, accused him of implying that all small businesses were trying to dodge taxes.
"There are so many cash businesses," Mr Bone said. "If you go into a cafe for a cup of tea you would not expect a receipt for it. If you were running a fish and chip shop you do not always give receipts.
"It shows a complete lack of understanding of business. Is he trying to imply that if you are a small business that deals in cash, you are trying to dodge tax?
"I think it shows how completely out of touch he is with small business. There is an implication that everybody is out to fiddle their taxes. It is just wrong."
In recent weeks, Mr Balls has been asked to answer accusations that the Labour Party is anti-business, but has insisted it has a track record of supporting an "open, dynamic, wealth-creating, entrepreneurial economy".