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The Tax Gap
Years ago, almost nobody would have discussed the UK Tax Gap.
Yet now, each year in June, HMRC publish their Tax Gaps Report, in part as a result of the global financial crisis which put such matters on the public and political agenda.
The annual report provides an estimate of the tax gap across all taxes and duties administered by HMRC.
What is a tax gap?
The tax gap is the difference between the amount of tax that should be paid to HMRC, and the amount that is actually paid.
So what goes into the ‘theoretical tax liability’? It’s the amount of tax that should in theory be paid if all individuals, businesses and companies complied with the letter of the law and HMRC’s interpretation of Parliament’s intention in setting those laws, referred to as the ‘spirit’ of the law. In simple terms, the total ‘theoretical tax liability’ = amount of the tax gap + amount of tax actually received.
The tax gap figure reflects the gap remaining after taking into account all of HMRC’s compliance work, which is why it’s a useful tool for understanding the nature and driver of non-compliance. HMRC then use this to inform their compliance strategy, and to analyse which strategies are most effective at reducing it.
Importantly, it also provides taxpayers with information on tax compliance and creates greater transparency in the tax system.
There are several reasons why the gap exists.
Why is there a gap?
It may sound farfetched, but it is not possible to collect every bit of tax owed.
For example, if a business stops trading because they're insolvent then HMRC can’t collect any outstanding tax from that business.
Also, despite their best efforts, some taxpayers make simple errors in calculating the tax they owe. Whilst others simply don’t take enough care when submitting their tax returns, or don’t interpret taxation law correctly. However, there’s also tax evasion that contributes, as well as criminal attacks on the tax system.
Each year HMRC estimate how much the tax gap is, by using data and a variety of different analytical techniques. It’s HMRC’s best guess based on the information available to them. Whilst at the same time trying to factor in data errors and uncertainty.
That’s why HMRC assign an uncertainty rating for each gap component. Ranging from very low to very high alongside an error margin. The data is then revised and updated as more accurate data becomes available.
Perhaps surprisingly, Tax Gap Reports don’t look at Council tax, Business Rates, Vehicle Excise Duty, or even estimated fraud arising from the various COVID-19 support schemes.
However, they do look at VAT, Income Tax, National Insurance Contributions, Capital Gains Tax, Corporation Tax, Excise Duties including alcohol, tobacco and oils, as well as Stamp Duty Land Tax, Stamp Duty Reserve Tax, Inheritance Tax, Petroleum Revenue Tax, Landfill tax, Aggregates Levy, Air Passenger Duty, Climate Change Levy, Custom Duty, Digital Services Tax, Insurance Premium Tax and Soft Drinks Industry Levy.
The 2023 Tax Gap Report which covers the 2021-2022 tax year offers some interesting findings.
How much is it?
It is estimated by HMRC that the Tax Gap is 4.8%. This was £35.8 billion out of a total ‘theoretical tax liability’ for the year of £739.3 billion. This means that HMRC collected 95.2% of all tax due.
Looking at the overall long-term trends, the Tax Gap has actually steadily reduced. Going from 7.5% in the 2005-2006 tax year to an all-time low of 4.8% in 2021-2022.
Although, as with all statistics the headline percentage figure often doesn’t tell the whole story.
For example, the £35.8 billion Tax Gap has actually increased from £31 billion in 2020-2021. It’s only at 4.8% because the value of the total ‘theoretical tax liability’ has also gone up from £643 billion.
There are also interesting differences between individual taxes and customer groups, and bigger reductions in some areas compared to others. For example, the VAT Tax Gap has dropped from 14% in 2005-2006 to 5.4% in 2021-2022, compared to the Corporation Tax gap that has actually increased from 11.4% in 2005-2006 to 13.3% in 2021-2022. Whilst the Income tax, National Insurance Contributions and Capital Gains have the lowest Tax Gap at 3% in 2021-2022. However, as with all statistics it’s all in the interpretation.
Whilst Income Tax, National Insurance Contributions and Capital Gains has the lowest percentage of 3% in 2021-2022, these taxes actually represent 35% of the total monetary value of the total, at just over £12.5 billion.
This is followed by the 30% Corporation Tax gap proportion and 21% VAT gap share of the overall Tax Gap of £35.8 billion.
What is contributing towards the tax gap?
When it comes to customer groups, it’s small businesses that have the largest proportion of the Tax Gap at 56% in 2021-22. Compared to the Tax Gap from individuals at just 6%.
HMRC are keen to also understand the behaviours that are contributing to the annual gap. By understanding these, HMRC is able to put in place appropriate strategies to tackle them. For example, in 2021-2022, HMRC found that failure to take reasonable care accounted for the largest proportion of the Tax Gap at 30%. This is up from 24% in 2019-2020.
Error and business accounting mistakes accounted for the second largest share at 15% in 2021-2022 followed by tax Evasion at 13%. The share of the Tax Gap due to criminal activity accounts for 11% of the overall amount in 2021- 2022, down from 15% the year before, and the smallest proportion of the Tax Gap at 4% comes from tax avoidance.
HMRC is the only tax authority in the world that measures and publishes the annual data in such a comprehensive way, by covering all the taxes, levies and duties it administers. Good use of taxpayers money? I’ll let you decide on that one.