According to the official tax gap figures for 2018/19 published on 9 July this year, the UK is one of the most tax-compliant nations on Earth. The latest official estimate of the tax gap – which is the difference between the amount of tax theoretically payable to HMRC and the amount actually paid – puts it at £31bn, which is 4.7% of tax liabilities. That indicates that an estimated 95.3% of the tax owed is collected and paid to HMRC.
How the tax gap is made up
Over the past 15 years, that official estimate of the tax gap has hovered at between £30bn and £38bn. In 2005/06 it was £32bn and 7.5% of tax liabilities, while today - at £31bn - it has shrunk to 4.7% of tax liabilities. This may be a sign of the growth in tax revenues, and perhaps more efficient collection over the intervening period, which has also seen a plethora of anti-avoidance legislation (the GAAR, follower and accelerated payment notices, the requirement to correct offshore non-compliance, a range of enactments aimed at those who facilitate tax avoidance, to name just a few).
The official estimate takes account of taxpayer behaviour, type of tax and taxpayer group. The total of £31bn is analysed with respect to each of these features.
The behaviour component is split between failure to take reasonable care (£5.5bn), legal interpretation (i.e taxpayers taking a different view of the law from HMRC) (£4.9bn), evasion (£4.6bn), criminal attacks (£4.5bn), non-payment (£4.1bn), straightforward error (£3.1bn), the informal economy (£2.6bn) and avoidance (£1.7bn).
Looking at type of tax, measurement of the tax gap shows, as one might expect, income tax, NICs and CGT accounting for the lion’s share (£12.1bn) along with VAT (£10bn) with corporation tax (£4.4bn), excise duties (£2.8 bn) and other taxes (£1.7bn) trailing behind.
As for composition of the tax gap by taxpayer group, small businesses account for £13.4bn while large business comes a long way second at £5.3bn. Criminals are not far behind (£4.5bn), then mid-sized businesses (£3.7bn) and individuals (£2.4bn). The wealthy, at £1.7bn, represent the smallest segment of the tax gap, contrary to popular supposition which attributes the bulk of tax leakage to rich tax avoiders.
The official methodology used by HMRC, which is in accordance with international practice, is a mixture of ‘top down’ and ‘bottom up’.
‘Top down’ methods are defined as ‘use [of] external independent data sources to estimate total consumption of taxable products to calculate the total theoretical liabilities; the tax gap is the difference between the total theoretical liabilities and the tax actually paid’. It is used, for example, to calculate the VAT gap in the above figures.
‘Bottom up’ methods are used to calculate the tax gap in the context of direct taxes. They are a combination of analysing the results of random enquiry programmes, statistical methods to extrapolate the results of analysing risk-based enquiries carried out, use of management information such as risk registers, accounting data, and ‘other databases or systems used to manage HMRC’s business’, and a range of experimental methodologies where there is no direct measurement data.
These methods are used to analyse each component of the tax gap, and are selected on the basis of factors such as the availability of good quality data and level of detail required. So, for example, the small businesses and PAYE components of the tax gap are quantified by using data drawn from random enquiries to estimate the extent of under-declaration, while the mid-sized and large business tax gap is ascertained from statistical analysis of risk-based enquiries. Experimental methodologies are used to produce illustrative estimates, for example to assess the size of the informal economy.
The results are subject to a degree of uncertainty, reflecting a range of assumptions and possible errors which are catered for by, in some cases, producing an upper and lower estimate (e.g beer duties) or a margin of error (e.g accurate within, say, 95%). The tax gap estimate is then based on under-declared liabilities as ascertained by the various methods described above (including a multiplier to account for undetected and undeclared liabilities), plus amounts due but unpaid, minus amounts recovered as a result of compliance activity.
The avoidance tax gap
Perhaps the most surprising aspect of these results is the small size of the tax gap attributable to avoidance. Some commentators say that HMRC grossly underestimates the figure for tax avoidance, citing numerous schemes – perfectly legal – to route tax liabilities to offshore jurisdictions where rates of tax are low. Others say that HMRC does not carry out enough investigations – that the samples are too few to be representative.
HMRC admits that there are issues with the quality of the data available to calculate the avoidance tax gap. The aim is that the figure should represent so much of the difference between the amount of tax that individuals and corporations would pay to HMRC if they were complying with the letter of the law and HMRC’s interpretation of it, and the amount actually paid, as is attributable to avoidance activity. It is calculated by looking both at schemes disclosed under DOTAS and schemes that are not disclosed, estimating the amount of ‘tax under consideration’ in both ongoing and completed enquiries, and comparing it with the estimated compliance yield. The difference is the tax gap attributable to avoidance.
These estimates are no doubt fairly conservative, though realistic. They do not take account of tax which is not due to the UK revenue in the first place. As more information on avoidance schemes and how many use them becomes available, estimates are revised accordingly, informed by the results of completed enquiries over time. The evidence base is continually growing and will doubtless produce more accurate estimates as time goes on.
On the whole, although there must be assumptions and margins of error, I would give HMRC’s figures the benefit of the doubt. However, even if one were inclined to argue that the tax gap is underestimated, one thing is plainly apparent – the vast majority of revenue comes in without the need for compliance activity.
I remember chatting once at an academic conference to a political scientist from another jurisdiction who told me how envious the government in her country was of the UK. Our level of general tax compliance was such that we could focus on clamping down on tax evasion and countering tax avoidance schemes, while in her country the government could not even begin doing that until it had its problem of corruption under control.
Addressing the House of Commons Public Accounts Committee on 7 September, HMRC Permanent Secretary Jim Harra said that about 90% of tax collected had been through voluntary compliance by taxpayers, and only about 5% from compliance activity (Q 17). That is impressive by any standards; HMRC and the government must do their best to continue to earn that level of trust by maintaining those standards of accuracy and fair dealing that they aspire to in Your Charter.