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# Tax Gap: Preposterous nonsense or valid estimate?

9th Jul 2018
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## Wendy Bradly has re-examined the methodology behind HMRC's tax gap figures and concludes that the calculations are based on some very dubious reasoning.

Last month I looked at HMRC’s tax gap documents and argued that they did not justify the administrative burden of Making Tax Digital. It was suggested on Twitter that I may have misunderstood the way the figures were put together in respect of the direct tax gap, so I went back to check.

## Recap

The direct tax calculation is based on the amount of extra tax found to be due from an extremely small number of random tax enquiries; see table H1 in the Methodology document. Also I know from my experience of working tax enquiries as an HMRC officer that not all cases picked for enquiry are fully worked.

## Further questions

I asked HMRC whether I was correct to say that it:

1. Investigates a small number of random cases;
2. Assumes all unworked random cases have the same ratio of errors as the worked cases;
3. Multiplies step 1 number using figures taken from US Random Enquiry Programs (para H28 of the methodology doc) and then
4. extrapolates the result to the full UK taxpayer population.

The suggestion was that step 3 and step 4 were the same process, so that in essence I was accusing HMRC of "multiplying by the number they first thought of" not once, but twice.

Not so. HMRC confirmed my understanding of the third step is correct. The process really does seem to be investigate > extrapolate > multiply > extrapolate again.

## Take it apart

Let's look at those steps in reverse.

Step 4

“Extrapolate the result to the full population" is a reasonably scientific method, except you have to remember that you're starting from a very small number and assuming the results apply to a very large number. It's like battleships –one space to the left in your random selection and you hit a giant battleship, one step to the right and there's nothing at all.

Step 3

Adjusting the figure by a multiplier derived from the US random enquiry programme troubles me.  The US tax system, and particularly the US tax administration, are quite different from the UK system.  Just about every taxpayer in the US is required to complete a personal tax return, where as only around one quarter of UK taxpayers are required to complete a self assessment return. There is an obvious "not comparing like with like" issue.

As for using a multiplier derived from a supposed metric of tax officers' success rates, I would need to be persuaded that US tax officials and UK tax professionals were looking for the same things in the same way after the same kind of training and experience. It's like looking at the number of bad eggs you get in your grocery shop and assuming you'll need to discard the same number of oranges.

Step 2

The second "adjustment", assuming that any unworked random enquiries have the same proportion of errors as the fully worked ones is, as I discussed in my earlier article, at best a dubious proposition. Random cases are selected at random and are are de-selected for a reason. The reasoning  for deselection is not in the public domain, but some possible reasons are not hard to fathom: this person is too old, frail, sick… Does that really sound as though the worked and unworked random cases will have the same profile?

Step 1

Finally, back to the starting point: the small number of random cases. 2763 selections (table H1 in the Methodology document) of how many returns (10 million in HMRC's "record breaking" stats here, though that's all SA returns, not just businesses).

## What does HMRC say?

When I asked HMRC to check my workings I also asked it for a quote and this was offered from Jon Thompson, HMRC’s Chief Executive:

“The UK is the only country in the world to regularly publish their tax gap in detail and at 5.7%, it remains at its lowest for five years. I am pleased that the downward trend shows HMRC and HM Treasury’s continued hard work to tackle evasion and avoidance is working.

“HMRC is also working hard to help taxpayers get their tax right by offering support and investing in digital services to improve businesses’ record keeping and reduce errors.”

This doesn't address my point. If the intermediate stages were cut out of the direct tax gaps calculation and the figure was simply the results of the random enquiries extrapolated to the rest of the taxpayer population, would the "downward trend" continue on the same trajectory? If so, why bother fiddling about with the headline figure at the risk of your credibility?

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### Replies (12)

By Vaughan Blake1
09th Jul 2018 11:08

Rather than spend time using dodgy statistics, why not just say that the tax gap is £BIG, and move on, devoting resources to reducing it to £NOT-SO-BIG.

MTD will have little impact on the tax gap. Mistakes will still be made (both in HMRC's favour as well as not!), the 'black' economy won't come out with their hands up and it will be business as usual.

More proper 'heavy duty' PAYE & VAT visits plus some sleuthing by HMRC into the black economy please.

As an aside, I am appalled that after a fair number of VAT visits, problems are discovered, the inspector goes away promising a letter setting out the issues/underpaid VAT, only to never be heard from again. What a waste of resources!

Writing up the books more frequently is more likely to increase the expenses column, not the sales column, as it is the fiddly small expenses that are likely to be forgotten over time.

Thanks (5)
By johnjenkins
09th Jul 2018 11:20

Good article that says what we all have known for many years and that is HMRC will "bump up" the figures to get Government to think their way.
MTD is an absolute disaster that cannot and will not work in the time scale HMRC want. I still doubt if small business will actually comply with the "digitisation" and quarterly "reports" of MTD.
Now if HMRC was to produce a spreadsheet or input format that complied with MTD and made it available for free there could well be an uptake within the small business sector.

Thanks (4)
By Michael C Feltham
09th Jul 2018 11:22

All such "Calculations" are the result of extrapolation!

For example, how often have your client's received statutory enquiry forms from ONS demanding details of sales and expenses?

I have seen ONE ONLY in approx 40 years of practise.

ONS Business Surveys aimed at SMEs are in fact rare: however, SMEs represent circa 47% of private sector GDP and around 48% of employment.

Ergo: the rest is plain guesswork.

"Lies, Damned Lies and Statistics!"

Benjamin Disraeli

Thanks (1)
09th Jul 2018 16:32

"ONS Business Surveys aimed at SMEs are in fact rare"

Not quite so rare, as I completed one a few days ago. This was, however, one issued after a break of 5 years since the last one was issued, so part on an ongoing sequence I believe.

I still cannot work out just what they get from these surveys. Small Ltd company businesses are not good indicators of profitability as the profits that the Company makes varies according to the bonuses, pension contributions and other non-trading (but legal) payments made by the Company that have little to do with trading performance.

Low salary/high dividend situations clearly do not fully represent the profitability of a small Ltd Company for statistical purposes.

Still it keeps the folk at the ONS in jobs.

Thanks (2)
By Michael C Feltham
09th Jul 2018 17:13

Quote:
I still cannot work out just what they get from these surveys.

They are used, together with analysis of VAT filings, to extrapolate probable GDP.

It is all guessology...

Thanks (2)
09th Jul 2018 17:50

I do know what they get from the surveys, but my point was that it is clearly of no practical use.

As you say, guessology.

Thanks (0)
By johnjenkins
10th Jul 2018 11:11

They get the "tax gap" figures from all their statistics don't they.

Thanks (1)
By Michael C Feltham
10th Jul 2018 11:29

johnjenkins wrote:

They get the "tax gap" figures from all their statistics don't they.

In reality, John, no one can calculate the value of the black market in goods and services.

For example, there are now, probably, two million illegal immigrants embedded in the UK: most of them working.

Mainly "off the cards".

And what about profits from illegal drugs? Massive amount.

I still maintain, MTDfb will become a driver for the black economy: in the same way that VAT has.

Government, Treasury and HMRC are living in a dream World.

If government really want to eradicate Tax Avoidance and more critically, Tax Evasion, then drastically reduce taxes!

Thanks (5)
By johnjenkins
10th Jul 2018 13:50

My thoughts entirely.

Thanks (1)
By Nick Graves
11th Jul 2018 11:11

Thanks to Wendy for taking the trouble to discredit these allegations. We suspected as much all along.

The Law of Unintended Consequences also implies that the Black Market will increase post-MTD as those on the margins CBA with it.

So, a lot of tax complexification to achieve little or nothing, apart from increased funding for HMRC. And at what value-subtracted cost to the wealth-generating part of the economy?

Thanks (1)
By I J Lessels
18th Jul 2018 15:34

I see they are assuming we are like the USA. What happens if you assume we are like Greece? Just wondering...

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By AndrewV12
17th Sep 2018 10:10

Good article challenging assumptions, the Uk taxgap is estimated to be 33 Billion.
There are 30.3 million tax payers in the UK, so divide one from other, thats an average underpayment of £1,089.11, that seems a reasonable figure (assuming my calculations are correct).
Some may say what about those who should pay tax but do not and are not in my 30.3 million figure above, I say there are probably a lot of pensioners who have a state pension and small private pension which means they pay tax, so i say 30.3 million is just about right. Mmmmmmm who knows.

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