The UK government recently released its estimate that the tax gap for 2019/20 is £35bn, which amounts to 5.3% of the total tax liabilities which fell due that tax year. The government defines the tax gap as ‘the difference between the amount of tax that should, in theory, be paid to HMRC, and what is actually paid’.
International issue
The fact that HMRC is estimated to have collected 94.7% of all taxes due seems like a positive achievement, when compared with many developing countries, which often have far higher tax gaps. For example, it has been estimated that in India as little as one third of all taxes due are actually paid.
Many believe that the rise of the digital economy will reduce tax evasion globally, as transactions become more traceable and tax authorities look to the tech companies to provide them with the details of taxpayers trading via their platforms.
In the US, the Biden administration is determined to reduce the tax gap. Natasha Sarin, deputy assistant secretary for economic policy, recently made the case for a ‘robust attack on the tax gap’ saying that in the US, the tax gap ‘totals around $600bn annually and will mean approximately $7 trillion of lost tax revenue over the next decade. The sheer magnitude of lost revenue is striking: it is equal to 3% of GDP, or all the income taxes paid by the lowest earning 90% of taxpayers’.
Sarin says the US will focus its compliance efforts on higher earners, on the basis that ‘tax evasion is concentrated toward the top of the income distribution because higher-income taxpayers have the ability to tap into the services of accountants and tax preparers who help shield them from bearing their true income tax liability’.
What is the UK doing?
Here in the UK, the figure provided by the government can in reality only be an estimate of the tax gap. Such an estimate is of course only as good as the data relied upon to create it.
The government boasts that the tax gap, expressed as a percentage, has reduced over time, saying that, ‘since 2005 to 2006, where the tax gap is estimated as 7.5% (£33bn), the tax gap has broadly declined to 5.3% (£35bn) in 2019 to 2020. Small peaks are seen in 2008 to 2009 at 6.9% (£33bn) and 2013 to 2014 at 7.1% (£37bn), with a slight upturn in 2019 to 2020’.
Despite the decline in percentage terms since 2015/16, from 5.7% to 5.3% however, the amount of unpaid tax has actually increased compared with 2019/20 from £32bn to £35bn. This is due to an increase in the estimate of the total amount due.
Where is the tax gap?
The government breaks down the sources of the tax gap as follows: ‘Failure to take reasonable care’ accounts for the largest proportion of the tax gap at 19% (£6.7bn), whereas avoidance accounts for the smallest proportion of the tax gap at 4% (£1.5bn). Legal interpretation, evasion and criminal attacks are similar in size at 16% (£5.8bn), 15% (£5.5bn) and 15% (£5.2bn) respectively. Non-payment is 11% (£4bn billion), followed by error at 10% (£3.7bn) and hidden economy at 8% (£3bn).’
Hidden economy
It is estimated that some £14bn of the tax gap is due to evasion, criminal activity and the hidden economy. Yet the accuracy of the estimates for the hidden economy are, by their very nature, impossible to verify since that economic activity is hidden. In 2017, government research into the UK’s hidden economy covered three key types of hidden economy behaviours:
- moonlighters, whose hidden economy activity supplements declared activity (57% of the hidden economy population);
- ghosts, who reported that they have not declared any of their sources of income (whether taxable or non-taxable) to HMRC (38%); and
- VAT non-registered, businesses that are assumed to have a turnover over the VAT threshold and are not registered with HMRC for VAT (5%).
The types of activity that take place cash in hand often include things like caring, housekeeping, repairs, maintenance, gardening work and cleaning. The 2017 research also mentioned ‘service activities, such as hair dressing, dog walking, laptop repairs, ironing services’. Clearly, it must be next to impossible for the government to have reliable figures as to the impact of such diverse activities on the tax gap.
Since tax evasion is a crime in the UK, it is arguable that there is a false distinction made between tax evasion in the hidden economy and criminal activity per se. However, the idea that the government’s estimate of the total turnover of the UK’s criminal underworld could be remotely accurate also seems fanciful. How could such an estimate be accurately obtained? Does HMRC send out anonymous surveys to criminal gangs, requesting their financial data?
How the tax gap is split between different tax sources
The government’s recent data breaks down ‘the total theoretical liability by type of tax’. The latest data suggests that the tax gap for income tax, NICs and capital gains tax is the biggest at £12.6bn, which while it is the largest figure in tax terms, only represents 3.5% of the total liabilities due for these three taxes, and so has the smallest shortfall for all of the taxes.
The VAT gap comes close behind at £12.3bn, representing 8.4% of the total liability. HMRC consistently seems to struggle to collect VAT and while this may be due to a combination of factors, are there any recurring themes that government and HMRC can learn from?
By comparison, corporation tax, excise duties and other taxes have estimated tax gaps of 8%, 5.9% and 4% respectively. Government is hoping that the collection of data and sharing of information between different tax jurisdictions will help them in closing the perceived tax gap.
What are governments doing?
However, as has been shown by the recent agreements reached by the G7 countries and the OECD relating to the taxation of multinational corporations and how tax revenues will be shared, the collection of tax and the drive to reduce the tax gap is of international concern. The current pandemic has seriously damaged the world’s finances and so the need to reduce the fiscal deficits are at the top of many agendas.
The report highlights that one of the ways HMRC wants to improve how the tax system operates is to reduce the time between when income or gains occur, and tax is paid. However, as has been recently shown in the UK, delays have been announced, both in introducing Making Tax Digital for Income Tax and to the basis periods for tax purposes. While there are good reasons for the delays, it does raise concerns about how much real desire there is in closing the perceived tax gap.
There is going to be a need to invest in both the UK and US tax systems, firstly to ensure that there are sufficient trained staff, secondly, in educating taxpayers about their responsibilities, thirdly ensuring unexpected tax anomalies are closed and finally the use of data to try to find potential areas where tax is being lost. The potential prize is large and may help governments to reduce the size of their current budget deficits. However, do politicians have a real desire to solve the problem, especially where there are upcoming elections?
Raising taxes does not win elections and while many people agree that something needs to be done, they do not believe it applies to them. Whatever action is taken, it will not ever fully resolve the tax gap as many ghosts and moonlighters will still stay in the shadows hiding from the tax authorities.
