UNRAVELLING THE TAX GAP

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UNRAVELLING THE TAX GAP

HMRC recently issued a note about calculating the 2014/15 tax gap.  This tells us that the tax gap for 2014/15 was some 6.5% of the total tax and duties due to HMRC.  It also says that “the estimate announced for the previous year has been revised upwards from £34bn to an actual figure of £37bn”.

I am not sure that it is helpful for the government to lie to the citizenry.  But I suppose that when it ought to be obvious that it is a lie – as it is surely not possible to “estimate” an “actual figure” that may not matter too much.  One can replace an estimate by an actual figure and one can refine an estimate to produce a more accurate estimate – which is what HMRC have done – but there will always be a fundamental difference between an estimate (an educated guess) and an actual figure (a fact).

The briefing note is of course little more than an advertising puff for the full 86-page report, which is a lot more honest.  So what is the tax gap?  HMRC say it is the difference between the amount of tax due and the amount collected.  They point out that it is impossible to collect every penny theoretically due, “for example, we cannot legally collect taxes from companies that owe tax and are insolvent”.  I like that word “legally”.  If HMRC believe that there are illegal ways to collect tax from people who have no money, perhaps they should explain what they are.  In the real world if a person has spent all his money he cannot pay anything.  But I digress.  The full report breaks down the tax gap as follows.

Criminal attacks                                  £4.8bn                                     13%

Evasion                                                  5.2bn                                     14%

Hidden economy                                 £6.2bn                                     17%

                                                                                    £16.2bn           44%

Avoidance                                                                       2.2bn             6%

Non-payment                                                                  3.6bn           10%

Legal interpretation                            £5.2bn                                     15%

Failure to take reasonable care            5.5bn                                     19%

Error                                                    £3.2bn             £13.9bn             9%    

                                                                                    £35.9bn          103%   

I have totalled the first three items together because they are all different forms of theft.  I assume that HMRC have split them because they try to counter them in various ways.

This is an interesting table.  44% of the £6.5bn shortfall, or £2.86bn is lost due to theft.  That is obviously an estimate.  If HMRC knew how much had been stolen from taxpayers they would also know who stole it and would presumably recover it.  The reality is that they do not know, because nobody knows.  Many put the figure much higher.

Bearing in mind the vast amount of both government expenditure and new legislation designed to combat tax avoidance, it is interesting to learn that this actually cost taxpayers only £2.2bn in 2014/15 and represented a mere 0.39% of the tax shortfall.  Indeed the vast majority of this figure is not a shortfall at all.  It will be collected (with interest at a rate that exceeds a commercial rate) in later years because most attempted tax avoidance fails and the tax has to be paid (or will fall into HMRC’s non-payment category) in a later year.  Where avoidance is successful, it is not part of the tax gap either (under HMRC’s definition) as the tax will never have been “an amount of tax due”; it is an error in HMRC’s calculation of the tax due, arising from a misunderstanding by HMRC of the tax laws.

Non-payment is factual and there is not much to say about it; even HMRC cannot stop people becoming insolvent.

The three remaining items are all estimates.  How accurate they are is questionable.  HMRC enquire into a small number of cases.  Those enquiries throw up areas where the taxpayer has taken a different view from HMRC.  In most cases the two sides compromise.  HMRC then consider imposing a penalty for the extra tax that becomes collectible as a result of their challenge.  If the taxpayer accepts a penalty, that extra tax is labelled as arising from failure to take reasonable care; if he doesn’t, it is attributed to error.  If the dispute has not been resolved by the time HMRC prepare their statistics, the tax HMRC are claiming is labelled as lost due to legal interpretation.  The statistics are generally based on HMRC random enquiries.  They do a very tiny number of random enquiries.  I do not know how many but I would be surprised if it is more than 1,000.  They then assume that the extra tax they pick up from that small number is representative of the whole body of taxpayers.  So if they pick up extra tax on, say, 200 of their 1,000 random enquiries they assume that 20% of the 9 million tax returns they receive are similarly wrong.  That may or may not be a correct assumption.  I have no doubt that it is a statistically reasonable one. 

The legal interpretation category is a bit more controversial because most challenges of legal interpretations take years to resolve.  Some, or indeed all, of that £5.2bn may be tax that will ultimately be collected.  It may equally not be tax at all but an amount that HMRC thought was due because they misunderstood the law.  This means that projecting from the sample to the general body of taxpayers is fairly pointless.  It is improbably that other taxpayers will be interpreting or misinterpreting exactly the same bits of legislation.

The real breakdown of the tax gap is therefore as follows:

tax stolen (estimated)                                                                                    £16.2bn

tax lost because HMRC did not manage to collect it in time                3.6bn

tax lost because HMRC have not been given the resources

   to do more enquiries                                                                        £13.9bn

                                                                                                            £33.7bn

tax that will be paid late as a result of attempted

avoidance will never have actually been due as HMRC

misunderstood the law                                                                           2.2bn

                                                                                                            £35.9bn

This raises interesting questions about HMRC’s use of resources.

ROBERT MAAS