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How do we tackle the tax gap?

12 August: The National Audit Office issued a report on what HMRC and HM Treasury have been doing to close the gap between expected tax receipts and the amounts collected.

The National Audit Office (NAO) has issued a report looking at the progress made by HMRC and HM Treasury to reduce the difference between what is owed in taxes and what is eventually collected.

The 2018-19 tax gap was estimated at £31bn, 4.9% of the £628bn collected by HMRC that year – or 4.7% you include estimated uncollected amounts. This is a sizable shortfall but a significant improvement on the 7.2% that went uncollected in 2013-14. Our full breakdown of the report covers the salient points in detail. 

The effectiveness of the tax system relies heavily on taxpayers reporting and paying their taxes in line with legislation, with 90% of taxes paid in this way in 2018/19. Mistakes, whether made inadvertently or on purpose, as well as different interpretations of what complex tax legislation means, make it harder for HMRC to ensure it has collected the full amount of tax believed to be due. 

Of the £628bn tax collected in 2018/19, £34bn was recovered via HMRC compliance activities – ranging from educating businesses and individuals on the correct way to calculate their taxes to criminal fraud investigations.

Not all factors that affect the collection of tax are within the control of HMRC. The state of the economy, more people becoming self-employed and perceived unfairness in tax rules can lead to less tax being paid. HMRC encourages voluntary compliance and aims to make it harder to be non-compliant – for example, by designing the tax system and tax returns to make it easier to be compliant.

The exact range of the tax gap is challenging to calculate because, by its very nature, the tax gap is hidden and obscure. That said, HMRC’s analysis is one of the most comprehensive studies of the tax gap available internationally.

In previous reports, the NAO and the Committee of Public Accounts (PAC) have recommended that HMRC obtain a better understanding of the cost and returns of different compliance activities. They have also highlighted that the quality of the service provided by HMRC impacts on whether or not the customers are likely to think that tax evasion is acceptable.

A longstanding request from PAC is that HMRC set a target by which they wish to reduce the tax gap. However, HMRC does not feel it is right to be judged on such a KPI, preferring to look at the movement in the tax gap over time and at the cost-benefit of compliance activities undertaken.

HMRC has focused on ‘upstream’ activity over the last few years, being targeted work aimed at preventing non-compliance in the first place. Routine compliance work has reduced by a quarter over the previous four years. Still, individual plans to tackle the main risks to non-compliance have helped to change attitudes to avoidance behaviour over time.

The compliance yield measure is just one way of estimating the additional tax as a result of its actions and HMRC is developing a broader set of measures to reflect levels of trust in the tax system and the deterrent effect of its actions.

Alison Ring, director for public sector at ICAEW, said:

“The NAO has given HMRC a pat on the back for its progress in reducing the tax gap and for positive rates of return on compliance activities ranging from 7:1 to 44:1. Targeting mass-marketed tax avoidance schemes has been one area that has yielded higher tax receipts, albeit not without some controversy in high profile cases.

“Inevitably taxpayers will always be looking to exploit opportunities in the tax system or will struggle to interpret complex tax legislation correctly, and so there will always be a gap between what is due and what is recovered. Despite that, the NAO highlights that progress is possible, even if it says HMRC ‘could do better’ by applying successful approaches more broadly.”