On 7 April 2022, the House of Lords is due to consider the following question for short debate tabled by Lord Sikka (Labour):

To ask Her Majesty’s Government what assessment they have made of the HMRC report ‘Measuring tax gaps 2021 edition: tax gap estimates for 2019 to 2020’, published on 8 February 2022.

The HMRC report was originally published in September 2021. On 8 February 2022, HMRC published an update to correct an overestimation in the corporation tax and overall tax gap statistics for 2018/19 and 2019/20. In 2019/20, the corporation tax gap was estimated at 7.2%, not 8% as stated in the original publication. The overall tax gap was estimated at 5.2% of total tax liabilities, not 5.3%.

HMRC said:

These corrections will not be reflected in our ‘Measuring tax gaps 2021’ publication. HMRC has published a correction note on GOV.UK in the ‘Schedule of updates and announcements for HMRC’s statistics’ and the start of the ‘Measuring tax gaps 2021 edition’ publication to ensure users of the statistics easily access the corrected statistics.

This briefing therefore summarises the findings of the publication as it was originally published. However, the corrected corporation tax and overall tax gap figures have been included in the relevant tables below.

Definition of the tax gap

The tax gap is the difference between the amount of tax that should, in theory, be paid to HMRC, and what is actually paid. In the ‘Measuring tax gaps 2021’ publication, HMRC said that in calculating the gap, it takes into account both the letter and spirit of tax law:

The ‘theoretical tax liability’ represents the tax that would be paid if all individuals, businesses and companies complied with both the letter of the law and our interpretation of Parliament’s intention in setting law (referred to as the spirit of the law).

The gap does not take account of taxes and charges administered by bodies other than HMRC. These include council tax, business rates, vehicle excise duty and the London congestion charge. Other exclusions include error and fraud in tax credits and in the Covid-19 support schemes.

How is it measured?

HMRC employs a combination of approaches to measuring the gap. For example, for VAT and excise duties it takes independent, external data to calculate a theoretical value of tax that should be paid, then deducts actual receipts. For other taxes, HMRC says it uses “internal data and operational knowledge to identify areas of potential tax loss”. It then estimates the gap using “established statistical methods and experimental methods”.

HMRC noted that there are uncertainties in the tax gap, but describes them as the “best estimates based on the information available”. It advised users to focus on trends over time rather than on absolute numbers.

How has the gap changed over time?

HMRC’s figures for 2019/20 suggest the tax gap was £35bn, equivalent to approximately 5% of total tax liabilities. This was an increase from an estimated £32bn for the previous year.

Figure 1 below shows how the tax gap has changed over time. In £ terms (the dashed line in the chart), the gap has been broadly stable since 2005/06, at usually between £30bn and £35bn per year. However, because the overall expected tax take has increased over time, the percentage estimated to be missing (the solid bars) has shown a downward trend.

Figure 1: Total tax gap in £ billion and as a percentage of total theoretical tax liability, 2005/06 to 2019/20

Graph showing the total tax gap between 2005/06 and 2019/20 in £bn a year and as a percentage of total tax liability. In £ terms it was relatively stable over the period, at between £30-35bn. In percentage terms it declined from approximately 7% in 2013/14 to 5% in 2019/20

Source: HM Revenue and Customs, ‘Measuring tax gaps tables’, 16 September 2021, table 1.3.

The £35bn tax gap in 2019/20 was approximately equivalent to the transport budget in the same year. It would have represented around 4% of total UK government spending.

Components of the tax gap

Table 1 below shows that the largest contributors to the tax gap are personal income taxes and VAT, representing 36% and 35% of missing tax respectively. Corporation tax represents a further 16%, with the remainder accounted for by excise duties (9%) and other taxes and duties. There have not been major changes in this split since figures were first calculated in 2005/06.

Table 1: Tax gap by type of tax, 2019/20
Personal income taxes VAT Corporation tax Excise duties Other taxes Total tax gap
£ billion 12.6 12.3 5.2* 3.2 1.6 35.0
Percent of total tax gap 36% 35% 16%** 9% 5% 100%

Source: HM Revenue and Customs, ‘Measuring tax gaps tables’, 16 September 2021, table 1.1. Figures may not sum to totals due to rounding. (*Corporation tax £ figure is from the corrected statistics published 8 February 2022. **Corrected percentage figure for corporation tax was not provided in the correction published 8 February 2022.)

Tax gap for each type of tax

Table 2 looks at the tax gap as a proportion of each group of taxes. It shows that VAT and corporation taxes have the highest percentages of uncollected tax. It also demonstrates that there have been notable falls since 2005/06 in the percentages of most taxes that are uncollected.

Table 2: Tax gap as a percentage of theoretical tax liability for each type of tax, selected years
VAT Excise duties Personal income taxes Corporation tax Other taxes Total tax gap
2005/06 14.1% 8.3% 4.5% 11.3% 4.5% 7.5%
2012/13 11.6% 5.3% 5.0% 7.4% 3.9% 6.7%
2019/20 8.4% 5.9% 3.5% 7.2% 4.0% 5.3%

Source: HM Revenue and Customs, ‘Measuring tax gaps tables’, 16 September 2021, table 1.2. (NB 2019/20 corporation tax and total tax gap percentages are from the corrected figures published 8 February 2022.)

Behaviours contributing to the tax gap

HMRC provided estimates of the different types of behaviour that contribute to the tax gap. It suggests that the largest factor was “failing to take reasonable care”, representing 19% of the gap. The next three categories, “criminal attacks”, “evasion” and “legal interpretation in complex transactions”, each accounted for between 15% and 17%. Smaller categories were “non-payment”, “hidden economy”, “error” and “avoidance”. HMRC defines avoidance as being within the letter of the law but not within its spirit.

Type of avoider

The statistics identified small businesses as the largest source of the tax gap. Table 3 below summarises HMRC’s breakdown by type of customer.

Table 3: Tax gap by customer type, 2019/20
Small businesses Large businesses Criminals Mid-sized businesses Individuals The wealthy Total
Percent of total tax gap 43% 17% 15% 14% 7% 4% 100%

Source: HM Revenue and Customs, ‘Measuring tax gaps tables’, 16 September 2021, table 1.4.

How does HMRC use the tax gap?

HMRC states that an awareness of the tax gap is useful because it allows HMRC to:

  • consider why there is non-compliance with tax rules and what can be done to reduce it;
  • assess the strategies that are more, and less, effective at addressing the gap; and
  • help to understand its long-term performance.

What is HMRC’s strategy to reduce the gap?

The Government’s statement of tax strategy, published in July 2020, said that HMRC’s proposals for reform of the tax system would also reduce the tax gap. It argued that compliance is promoted by creating a “trusted, modern tax system that makes it easy for taxpayers to pay the tax they owe”.

A key part of the Government’s strategy is its ‘making tax digital’ (MTD) programme. MTD aims to make HMRC “one of the most digitally advanced tax administrations in the world”. HMRC states this will make tax collection more efficient, more effective and make it easier for taxpayers to get their tax right. By reducing the scope for error, the Government believes MTD will contribute to reducing the tax gap.

Committee and National Audit Office reports

House of Commons Public Accounts Committee

In October 2020, a House of Commons Public Accounts Committee report on the tax gap concluded HMRC “needs to think fundamentally about how it collects unpaid tax”. It made several recommendations about how the tax gap is presented. For example, it argued that the Government quoted its estimates of the tax gap with too much precision. It suggested that HMRC present ranges of estimates rather than a single figure. It highlighted “substantial” revisions to previous estimates of the tax gap. However, it also called for more information to be published in certain areas. These included estimates for each of the regions of the UK and by sector of the economy.

The committee also commented on the effects of coronavirus. It observed that HMRC’s efforts to collect additional tax revenue had been affected by the pandemic. It said this was a result of prioritising the Covid-19 support schemes and responding to the needs of taxpayers struggling with the impacts of the pandemic. The committee reported that compliance checks fell from 62,000 in the first quarter of 2019/20 to 40,000 in the first quarter of 2020/21. In addition, it said there was “significant fraud and error” in the coronavirus job retention scheme, known as the ‘furlough’.

On MTD, the committee argued there were “indications that the costs imposed on taxpayers far exceed government estimates”. It urged HMRC further to consider “the support customers need and the costs it imposes on taxpayers”.

The Government’s response to the Public Accounts Committee report on the tax gap report accepted the need to be clearer about the uncertainties in the estimates. However, it rejected other recommendations, such as the publication of sectoral tax gaps. It said that data was insufficient to allow these without imposing further burdens on compliant customers who respond to HMRC surveys. The response also noted “substantial engagement” with businesses and representative groups on MTD.

National Audit Office

In July 2020, a National Audit Office (NAO) report concluded that HMRC had successfully reduced the tax gap by targeting the underlying incentives behind non-compliant behaviour. It also stated that HMRC’s work to tackle non-compliance offers good value for money, with a return of between £7 and £44 for every pound spent. However, the NAO argued that “lessons from these successes have not been applied more broadly, such as where taxpayers bend the rules or do not take reasonable care”. It also made recommendations to improve reporting of the tax gap. These included using more established methodologies in making the calculation and developing new measures of factors affecting the gap (for example, costs to taxpayers of complying with the rules).

The NAO recognised that tackling the tax gap may be difficult, because taxpayers and their advisers can change their behaviour in response to HMRC initiatives aimed at a particular area.

The NAO also reported that the UK’s estimates of the tax gap were lower than those of other countries that have made calculations. For example, the US estimated its tax gap at 14% and Italy estimated 18% to 19%. However, the NAO noted difficulties in making comparisons because of “methodological differences and the large number of influencing variables”. It said that for VAT, the UK’s estimate was near the median for EU countries.

House of Commons Treasury Committee

In a March 2021 report, the House of Commons Treasury Committee called for the Government to consult on a high level ‘tax strategy’, including principles for reducing the tax gap. The Government’s response to the Treasury Committee’s report agreed that public engagement on tax policy and strategy was important, but did not commit to drawing up a specific strategy for consultation. The committee objected that this response was unclear on why the recommendation had been rejected. In a further response to the Treasury Committee, the Government stated that pre-announcing broad tax policy could be counterproductive. It said that this approach could undermine the chancellor of the exchequer’s ability to support wider fiscal strategy in response to changing events. The Government also argued that such a strategy “would risk forestalling and other responses that would reduce revenues”.

House of Lords Finance Bill Sub-Committee

In a July 2021 statement on the Finance Bill, now the Finance Act 2021, the Government said that it would introduce, from April 2022, a requirement for large firms to notify HMRC where they have adopted an “uncertain” tax treatment. It said this would help to cut the ‘legal interpretation’ element of the tax gap. The House of Lords Economic Affairs Finance Bill Sub-Committee said that these plans were “poorly thought out” and that the Government should “look again at the cost of compliance and to consider whether the measure should apply so widely”.

External commentary

Writing for the campaign group Tax Justice, Professor Richard Murphy has argued that alternative approaches to measuring the tax gap produce the much higher figure of £120bn per year. He described the published data as “rough and ready”. He called for an independent assessment of the gap from a new Office for Tax Responsibility. He also suggested that HMRC should be given more resources to tackle the gap.

Paul Harrison, of accountant and consultant KPMG, noted that the element of the tax gap attributed to VAT rose from £10bn in 2018/19 to £12.3bn in 2019/20. He said this was “unexpected”, given that mandating digital filing for VAT under MTD was introduced in April 2019. He stated that part of the rationale for the reform was the expected reduction in the VAT gap. He further noted the Government had not provided an explanation for the increase in the VAT gap.

Hammat Verma and George Crozier, from the Chartered Institute of Taxation, also highlighted the absence of any indications that MTD is producing additional revenue. They said the programme might even increase taxpayer error and they emphasised the need for simplification of the tax system. They also called for continued HMRC investment in data analytics to tackle criminal activity.

Recent developments

On 23 September 2021, the Government announced delays to some elements of MTD. It said that MTD for income tax would now be introduced in the 2024/25 tax year. Changes to how self-employed profits are allocated to tax years (‘basis period’ reform) would also be delayed by a year.

Richard Wild, from the Chartered Institute of Taxation, welcomed the delay but said that it was still important to consider whether the new timetable was realistic to ensure businesses and individuals are prepared.

In the autumn 2021 budget and spending review, HMRC received a real terms increase in its budget of 1.2% per year on average to 2024/25. The Government said this included:

  • £292m across three years for “more resources to tackle the tax gap and ensure that those who should pay, do”; and
  • £55m in 2022/23 for the taskforce to expand HMRC’s compliance work and investigate fraud in the Covid-19 support schemes.

In the budget, the Government stated that it expects MTD to generate additional revenues of £1.6bn per year by 2026/27.

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This article was updated on 1 April 2022.

Cover image by Nataliya Vaitkevich on Pexels.