The Tax Gap is big - probably bigger than HMRC have admitted

HMRC have published their second (annual?) publication concerning the Tax Gap. This contains HMRC's estimate of the difference between total taxes paid and those that should have been paid if all individuals, partnerships and companies complied with both the letter of the law and HMRC’s interpretation of the intention of Parliament in setting law (referred to as the spirit of the law).

The total Tax Gap is estimated to have been £42bn in 2008-09 as compared with £38bn in the previous report - although that figure was restated as £40bn in the 2010 report due to a desire to present comparative figures to the nearest £5bn. The split of the Tax Gap across different taxes is revealed in this chart:

Of course the very idea of trying to estimate what is not being reported is fraught with difficulties. And HMRC's document admits this with statements such as:

"All of the tax gap estimates shown are subject to error.The main sources of error are random errors due to sampling and systematic errors due to assumptions used to derive the estimates. Where possible the range within which the true estimates would be expected to lie has been estimated. However for some taxes and components it has not been possible to provide a robust estimate of the error margin."

Whilst the report explains how the figures have been computed it does seem likely to underestimate the true Tax Gap. This must be due either to inadequate expert scrutiny within HMRC, incompetence or a deliberate effort to reveal how inadequate have been previous efforts to estimate the Tax Gap.

The report colour codes figures to distinguish how the figures have been computed:

Established methodology, estimate updated annually

Developing methodology, estimate updated annually - Used, for example, to estimate IT, CGT and NIC avoidance by individuals

Experimental methodology, not updated annually and illustrative indicators for gaps with no direct measure - Used, for example, to estimate IHT avoidance.

One critic of HMRC's calculations, Richard Murphy, explains some of the inadequacies on his Tax Research blog:

That Inheritance tax avoidance and evasion is £0.1 billion when this tax is so widely known as an ‘honesty box’ tax – requiring for a start retrospective declaration of gifts made in the seven years prior to death – of which the executors may well be wholly unaware?

That tax avoidance of income tax, Capital Gains Tax, and national insurance combined is just £1.4 billion when George Osborne admitted that avoidance of CGT alone was more than £1 billion in his June budget speech? So there’s almost no income tax avoidance at all then?

That the 20 million or so people who do not receive tax returns each year – including every single person who trades in the shadow economy – between them evade just £0.3 billion in income tax – when the World Bank says that the UK shadow economy is 13.5% of GDP?

He has also suggested that the real Tax Gap must be more than double the official figures. He estimates are also worked out carefully and suggest that tax evasion costs Britain £70bn and that tax avoidance costs us £25bn. He notes, for example that if the Tax Gap for VAT is estimated to be 16% of the VAT that should have been accounted for, then this suggests in turn that 16% of turnover that should have been subject to VAT has not been reported. I don't wholly agree with this simplistic approach but I do entirely accept that HMRC's figures probably UNDER-estimate the full extent of tax avoidance and tax evasion.

Equally, according to the FT, David Gauke, exchequer secretary, has said by reference to the official figures that:

“The tax gap number is staggering and this government is committed to taking the necessary action to bring it down – taking steps to reduce tax avoidance and evasion, including by the richest people in our society, so that everyone pays their fair share and we reduce the tax gap over the coming years.”

And this brings us onto my next blog post by reference to Danny Alexander's speech at the Lib Dems Conference.