The Tax Gap

by Tax Faculty Team on 26.09.2011 10:28

HMRC estimates the tax gap is down slightly, to £35 bn, in 2009-10


For the past couple of years HMRC has produced estimates of the tax gap for direct taxes as well as indirect taxes.


The latest figures show an estimated tax gap of £35 bn between:


‘the theoretical tax liability if all individuals and companies complied with both the letter of the law and HMR’s interpretation of the intention of Parliament in setting law (referred to as the spirit of the law).’


The equivalent figure for 2008-09 was £39 bn but much of the reduction is caused by the temporary reduction in the VAT rate.


The above quote is from the summary at the beginning of the document explaining the make- up of the tax gap. There is then a document which sets out the methodology used to compile the numbers and then a set of tables with the details.


It is inherently difficult to calculate the tax gap because you are trying to measure what is not there and quantify what potential tax liabilities people have deliberately tried to hide from the authority. HMRC’s figure is considerably smaller than the equivalent figure which the TUC published three or so years ago and the figure that civil society currently thinks is the real extent of the tax gap.


A major element in the tax gap is VAT where there was estimated to be over £11 bn of lost revenue in 2009-10.


In aggregate income tax, NIC and CGT caused £14.5 bn of lost revenue of which inaccurate self assessment returns account for £12.6 bn. The loss of tax from those who do not make returns or who have undeclared jobs ‘ghosts’ or second jobs ‘moonlighters’ is estimated at £3.4 bn.


HMRC has also recently published a working paper which explained why, along with almost every other revenue authority in the world, HMRC does not attempt to measure the direct tax gap on a top down basis. Rather it extrapolates from its enquiries etc which disclose the level of tax loss in individual cases to arrive at an aggregate figure.


We commented on that earlier HMRC working paper publication as follows:


‘If one can produce an accurate estimate of total income, including the income that is not declared to the tax authority, then it should be possible to apply the tax rate to that income and determine what direct tax should have been paid. The tax gap is then the difference between this theoretical total and the actual tax collected.


In practice there is no ‘source’ for data on this undeclared income because by its very nature it is not declared. Another defect of the top down approach is that even if one could arrive at a figure for the overall direct tax gap it wouldn’t provide an indication of where any revenue authority should concentrate its efforts to close that gap.’