Because you can't tax it.
She provides a service in exchange for money, so she is self employed. It can be taxed.
The gubment would have a hard time determining or even being aware of her income due to the exchange of cash, but if the income is ever tracked down, then it is taxed.
One thing to keep in mind is that the legalization of prostitution would likely lead to more check and credit/debit card transactions, thereby making at least some of the income traceable and more easily caught during an audit.
From there, if the I.R.S. knows you're making a living off of prostitution alone, but what you're reporting on a return or showing as received in your bank account isn't enough to live off of, then they will start to demand additional information. Failure to comply will result in fraud penalties, and depending on how the return was completed or what statements were made during the audit, criminal charges could be brought.
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