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The tax gap: An alternative view of HMRC’s performance

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20th Sep 2010
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As the department comes under increasing pressure to cut costs, critics have called HMRC's service levels into question. Tax editor Rebecca Benneyworth takes a detailed look at HMRC's performance.

Published on 16 September by the Office for National Statistics, the latest estimate of the ‘tax gap’ – the difference between the amount HMRC would expect to collect and the amount actually collected – makes for interesting reading.

Although entitled Measuring Tax Gaps 2010, the documents provides estimates of the tax gap in the UK for 2008-09, and follows a similar document published a year ago dealing with 2007-08, which was the first of this type of study. The methodology used to arrive at the figures in the report has in some cases been enhanced over the last year, and the Office predicts that as methodologies become more established and refinements are made, the figures produced will be more reliable.

Total tax gap
The total tax gap in 2008-09 is estimated to be £42bn (para 1.2). The Office sets out very clearly the types of error which the estimates may be subject to, but given that it is necessary to work with some figures, it is worth leaving consideration on the reliability of the numbers presented and look at the overall figures and their relationship to previous years.

The key elements of the tax gap for 2008 – 09 are as follows:

  • Indirect taxes contribute £19bn of the £42bn, or 45% of the total tax gap. This represents a tax gap in terms of indirect taxes of 12.8% (meaning that collection of indirect taxes is 12.8% less than it should be); VAT comprises £15.2bn of the total, and 36% of the total tax gap for the year. The percentage tax gap for VAT is 16%.
  • The total for direct taxes is dominated by Income Tax, NIC and CGT at £14.2bn, but only representing a gap of 5.4%. Although numerically large, the percentage under-recovered is small in relation to the total of those taxes, driven of course largely by the significant contribution of taxpayers within PAYE to this – for whom the ability to underpay is limited. Of the total of £14.2bn, inaccurate self assessment returns from individuals is estimated to contribute £5.8bn (although the estimate also indicates that this figure probably lies between £2.6bn and £10.8bn). Inaccurate employer returns contribute £3.2bn and ghosts and moonlighters total £3.1bn – the last figure the document suggests should be treated with caution as the methodology for arriving at it is not well established.
  • Corporation tax is a much smaller element of the tax gap in terms of absolute value, at £6.9bn, but this is a tax gap of 13.9% within the sector.

Trends
Comparing only to 2007-08, the percentage tax gap for indirect taxes was 10.8%, so 2008-09 has shown a rise of 2.0%; The VAT gap in 2007-08 was 12.5%, rising to 16% in 2008-09; this shows some cause for concern. However, Table 2.1 shows an estimate for 2009-10, with a VAT gap of 13.9%, showing at least development in the right direction. Para 2.19 indicates that a significant part of this (£1.6bn of the £3.5bn increase) is due to VAT debt write off, as a result of the recession, and that this also explains a significant part in the movement from 2008-09 to the estimates for 2009-10. So debt accounts for a rise from 12.5% to 14.2% in the VAT gap. There is no other explanation provided in the document for the balance of the increase in tax gap – in percentage terms the remaining 1.8% of total VAT receipts additionally lost in 2008-09 compared to 2007-08; it is clear that MTIC fraud is not the culprit as levels of this loss have stabilised since 2005-06. Why has collection of VAT been so poor?

The picture for direct taxes is somewhat better. The gap in income tax, NIC and CGT for 2007-08 was similar to 2008-09 at £14.1bn representing 5.3% of expected receipts. So 2008-09 shows a slight increase, with the self assessment gap static. Given that some level of tax gap will always be present, members may wish to consider whether this level of gap is acceptable, provided that HMRC “holds the line” and does not permit the figure or percentage to deteriorate.

For corporation tax, the 2007-08 gap was £6.5bn in cash terms, 12.3% of anticipated receipts. 2008-09 has shown a material deterioration to 13.9% - not as poor as in VAT but potential for concern.

Deeper analysis
There is a more comprehensive breakdown of some of the components of the direct tax gap over the period 1999 to 2007, which data has been used to compute the estimates used for the 2008-09 tax gap. It is estimated that 30% of SA returns show an under declared tax liability in 2006-07; this proportion has varied between 29% and 34% in the years tabulated in Table 8.2, with the most recent 30% showing a slight increase from 2005-06 at 29%, but overall an improvement on earlier years. Of this 30% of returns, it is estimated that the following monetary understatements apply:

  • 14% of returns show an under declaration of up to £500
  • 5% of returns show an under declaration of between £500 and £1,000
  • 11% of returns show an under declaration of over £1,000

However, looking only at the self employed and partnerships, the proportion of incorrect SA returns with under declared liability is estimated to be 45% in 2006-07 (down from the mid 50’s in years 2001 to 2004). 20% of returns submitted by the self employed and partnerships are reckoned to under declare tax due by over £1,000.

Although the tax gap in relative terms for this sector of the population is not large, these figures (based on sampling methodology applied to random enquiries) show cause for concern.

Finally, looking at PAYE data for a longer period, Table 8.5 makes it clear that non payment by SMEs (that is, debts written off) form a significant part of the estimated tax gap – in excess of 50% of the gap in the years 2004 to 2008. An interesting warning.

Conclusions
So many figures! I have barely touched on some of the detail of the report, but have tried to provide a picture of the efficacy of our tax authority. As a change from the ‘telephone not answered’ complaints and similar criticism, how is the authority doing in terms of getting the job done?

Although the data provided relates to past years, in my view the tax gap data presents cause for concern in relation to VAT – particularly as this is such a large component of the overall tax gap, and in view of the paucity of information explaining the deterioration in the position for the 2008-09 estimates.

Outside of this, I would invite members to draw conclusions about how they are doing. My own view, in short is “not as bad as I expected”, given the stick the authority has been getting recently; although some members may suggest that service deterioration has been rapid and recent, and may not show up in the tax gap estimates for some time, these figures did give me some small consolation.
 

Replies (20)

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By frustratedwithhmrc
20th Sep 2010 11:34

Simplification is the only way to 'Mind the Gap'

No doubt Richard Murphy will be along in a moment, to give his own viewpoint as to the tax gap.

Fundamentally, the problem is that the various tax codes have simply got out of hand. Too much complexity, too much Brownian micro management, too much political interference. I actually feel sorry for the staff at HMRC as they are required to deal with this nonsense.

The Office of Tax Simplification needs to throw away the entire thing and start again. They need to come up with a more simplified approach to the main issues of income tax (including PAYE), corporation tax, VAT and capital gains tax. When these have been bedded down (with transitional relief to ensure a 'revenue neutral' balance), they should then tackle the various other secondary taxes (SDLT, Vehicle Tax, sin taxes, etc.). Each tax should be reviewed on the basis of complexity, necessity and revenue.

The various regimes attempting to deal with evoidance and evasion in specific industries (CIS, IR35, etc.) should be done away with. In its place a General Anti-Avoidance Rule should be established and a new agency dealing solely with Criminal Prosecutions in relation to tax evasion.

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By NeilW
20th Sep 2010 12:02

Simplification and refocusing are the only approach.

I agree entirely with the simplification argument. There is no other alternative.

From a macro point of view the lack of tax collected has provided a small boost to the economy at the expense of distributional concerns, so I doubt that the government is that bothered about it at the moment - despite the rhetoric. The main issue at the moment is a chronic lack of demand in the economy.

But simplification shouldn't be just about the tax code. It should be about the services HMRC provides. Is there really a need for them to provide helplines and the like. Surely that would be better dealt with by accountants. Is it really necessary for them to provide software? Surely that should be dealt with by software providers.

HMRC should really scale back its operations to the core policing and central interface functions. That would save their 25% easily. And it would provide a welcome boost to accountants during a difficult time.

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By elansea
20th Sep 2010 12:24

Simpler, More Fair, and More Staff

The Office of Tax Simplification needs to concentrate on a simpler system as well as a more fair one. More fair in so far as Revenue errors should be dealt with and punished in the same way as their victims (sorry, "customers"). They should be given adequate staff to do the job properly and to police the system fairly. After all, the return on staff investment should be phenominal.

Fairer also means that those who take from the State are more rigorously policed too, so the welfare budget should come under the same micropscope and be dealt with in the same way.

Dream on...

 

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By ThornyIssues
20th Sep 2010 12:45

Simplification ........

As I've posted elsewhere on these fora, simplification is the only way forward and agree entirely with previous two posters.

Secondly, HMRC needs to be brought to book in terms of value on returns. They still seem to be burning money pursuing taxpayers without any thought s to the total overall cost. Take IR35 as an example. I seem to recall that they've only won 4 cases out of over 1600 cases they've brought against PCG members. How much has each case cost the taxpayer? Give QC costs alone, well into five figures I suspect. 

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By frustratedwithhmrc
20th Sep 2010 13:02

Not sure where I heard it from, but...

I seem to remember someone calculating that even for the 'successful' (from HMRC) extractions under IR35, it was effectively costing about £1.30 to collect every £1.00.

The problem is that the relationship between HMRC and an individual taxpayer is completely disproportionate. HMRC is able to act as judge, jury and executioner, whilst having no concern for costs by either side. Whereas even a taxpayer who has played it straight by the book and has obtained tax investigation insurance is still subject to the full reciprocity of the system. For most they are willing to settle with HMRC simply to end the stress and distraction from their businesses. This is true even where HMRC have little to no real basis for an enquiry.

We see this time and again. The only way to balance this is for taxpayers to be awarded compensation and HMRC penalized when unwarrented enquiries are launched. However, the likelihood of this happening is zilch. 

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By harestock
20th Sep 2010 13:37

Simplification & refocusing

I disagree with the suggestion that HMRC should do away with software for their imposed need to register VAT, y/end PAYE etc on line. The small bookkeeper (like me) should not have the expense of purchasing software just to post VAT & PAYE on line for 2 clients.

As for getting help from acccountants, why pay an accountant when the relevant information should be available from the organisation imposing the rules?

 

Harestock

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Nigel Harris
By Nigel Harris
20th Sep 2010 13:42

Not sure simplification is a simple fix

I'm all in favour of tax simplification, but I can't see that it is the solution by itself. After all, VAT is a pretty simple tax to calculate - just a percentage of turnover, no complicated reliefs and allowances - and yet under-collection of VAT represents over a third of the total tax gap according to these figures! The problem is also down to under-resourcing and inept management at HMRC - and, yes, the two go hand in hand. The last thing we need is to address only the first of these and end up with a Revenue service that costs us twice as much to run yet collects the same amount of tax!

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By adoggett
20th Sep 2010 14:36

The Tax Gap... Where you produce a system of taxation which is too complex or complicated, the taxpayer will not understand... and you cannot expect the taxpayer to keep asking for advice from professionals, who may not be able to answer..  You may lose income just by the fact that the taxpayer does not know what to do, or how to complete a form correctly. Each revision of tax, whether Vat National Insurance Multiple direct and indirect taxes... just adds another layer of complexity to the whole 'thing'.  So simplify without adding layers, ... all that penny grabbing over the last few years, 800 page budgets, virtually all of which were a waste of time... have now clogged the wheels of taxation.. and if the revenue do not have suffiient staff to carry out the job or oversee, then there is a big problem looming.. Pehaps it is now time for the Chancellor's post to become independent from government, similar to the Bank of England.. Ashley Doggett FCA

 

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By Nick Graves
20th Sep 2010 14:41

The logical consequence of the new penalty regime?

Looking at the VAT situation, I am beginning to wonder if the draconian new penalty regime may be affecting taxpayers' psyche? If you're gonna be hanged for a sheep, you might as well nick the whole bloody flock and the barn...

It is an obvious corollary to anyone with commonsense, which is why HMRC won't have though of it. I have heard the big triangualtion frauds etc are on the increase.

 

 

 

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By frustratedwithhmrc
20th Sep 2010 15:24

VAT is Simple?

I agree that VAT is simple at the basic level of guy walks into a shop and buys a TV and the shop charges 17.5%. From that perspective, it is simple. However it is when you add the various types of VATable and non-VATable supplies and what does a VATable business charge for a zero rated supply to Belgium for an end customer in Holland, etc. HMRC's VAT guide is already 200+ pages and probably more when considering all of the industry specific guidance notes.

The main problem with VAT though is various VATable organizations charging a 'discount for cash'. This is a massive problem at the moment in various Business-to-Consumer trades. Come January 2011 when it climbs up to 20% it is going to be a free-for-all.

Clearly this is evasion, but it is a non-linear problem. While the amount of evasion is small, it can be handled by government enforcement. As it becomes more widespread it becomes impossible to enforce, leading more people to evade it (i.e. a cascade effect). Once there is widespread evasion, it becomes impossible to enforce on even the most law abiding citizens.

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By DavidorJoy
20th Sep 2010 19:11

Short paid tax by S/E

So - how do they know tax is short paid

I would like to know How HMRC (aitch not Haitch) get their figures.

None of my 150 SA clients pay less tax than is due.

Complete rubbish, I feel.

David Harrison - thinking of early retirement.

 

 

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By ThornyIssues
21st Sep 2010 07:55

Simplification

Nigel says :-

I'm all in favour of tax simplification, but I can't see that it is the solution by itself. After all, VAT is a pretty simple tax to calculate - just a percentage of turnover, no complicated reliefs and allowances - and yet under-collection of VAT represents over a third of the total tax gap according to these figures! The problem is also down to under-resourcing and inept management at HMRC - and, yes, the two go hand in hand. The last thing we need is to address only the first of these and end up with a Revenue service that costs us twice as much to run yet collects the same amount of tax!

I fail to understand why a fully simplified tax system (lets talk about a fully implemented flat rate here) does not address the issues. Tax calculation becomes a simple percentage, requires vastly reduced HMRC manpower, vastly reduced HMRC computer systems which has cost £13Bn over the last ten years, gets rid of an 800+ page ESM and ultimately saves the public purse tens of £Bns. This of course has to go hand in hand with fully transparent pubic finance accountability in order that "the public" can see where their tax money is spent.

In countries where flat rate has been implemented, tax take has increased.

Simples!

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By abelljms
21st Sep 2010 09:17

Tax gaaaaaaap

 

There is no chance of a flat rate tax system, as anyone who thinks about it can rapidly see – all the vested interests say “great, …..but of course we need to allow for abc xyz”, so it sinks back to what we have now. Also those that allege they have tried it have not really, when you look at the detail, and they have gradually gone back to the old ways.

I agree regarding the comments on direct taxes like SA – what they are really inferring is lies on tax returns and claims to reduce tax bills that are inappropriate which is not quite the tax gap, but still important.

Biggest misstatement I know of currently on Corporation Tax is research and development claims – HMRC should tell every claimant to send in full documentation to support their claim – it’s simple when you get someone clever on the job.

The massive hole in finances is linked to VAT, and there real fraud is endemic in certain markets. Again HMRC have no idea what to do about it, as I was only telling an Excise lady yesterday, but I’m not disgorging the fixes for free.

 

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Rebecca Benneyworth profile image
By Rebecca Benneyworth
21st Sep 2010 10:16

Self employed gap

@DavidorJoy

Hi, the self employed percentages are based on a mathematical model using the results of random enquiries over the period 1999 to 2007. Although one could pick holes in the detailed methodology if one had full access to the models used, I suspect that this way of going about producing an estaimate is as good as it is going to get. I was shocked that the percentage is that high, and it gives me pause to think about why some officers come at enquiries thinking everyone is fiddling. They are wrong of course, but this is the first time I have really seen the detail. I wonder how the split between "represented" and "unrepresented" works here and what conclusions we (or HMRC) might draw from that. A complex picture though - as with many things in tax, nothing is ever simple!

As to simplification - I have my doubts whether simpler would reduce the tax gap.... One thing I am certain of is that the OTS (Office of Tax simplification) has its work cut out and I have grave doubts whether we shall see the sort of change lobbied for here..... when politics gets involved (as inevitably it will) the ability (and eventually the enthusiasm) to make radical change will be stifled.

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By Ken Howard
21st Sep 2010 10:39

After all, VAT is a pretty simple tax to calculate - just a perc

What about the different retail schemes available which a trader has to decide upon and operate?

What about importing and exporting goods and services?

What about working out what's exempt, zero rated, reduced rate and standard rated?

What about the zero & reduced rating on new buildings, conversions, holiday accommodation, etc?

What about VAT on providing education services or providing nursing/care services?

Is a pie or a cooked chicken zero rated or standard rated?

VAT is an absolute minefield - and now it's going to be 20%, getting it wrong is really literally going to be the difference between business success and failure as most businesses work with a profit margin of under 20% - get the VAT wrong and you're either 20% more expensive than your competitors or your profit suddenly turns into a loss when the VAT assessment arrives. 

One thing for certain - it's not "a simple tax" and it's not just "a percentage of turnover".

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By milseadas
21st Sep 2010 14:28

HMRC - A textbook example of how not to run a Government department-- mismanaged by a series of overpaid poltroons, overpaid senior managers who toadied up the greasy pole and are otherwise unemployable-wholesale disregard of professionally trained/qualified staff.  Years of lessons abandoned in the name of "modernisation".  

I could go on  and Yes I did use to work there 

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By aidan.sergent
21st Sep 2010 15:22

Tax Gap

Is there any indication within the report as to what element of the tax gap is represented by the drug trade or is this not addressed?

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Rebecca Benneyworth profile image
By Rebecca Benneyworth
21st Sep 2010 18:32

Drug trade

A very quick search of the PDF for the word "drugs" revealed no results. I'm not sure how illegal activities contribute to the tax gap, which is measured "top down" using GDP and "bottom up" using data such as I referred to above regarding SA shortfalls. I guess one would want to levy tax on drug profits if one had the chance but I don't think that is recognised as part of the tax gap.

Anyone else got a view?

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By ThornyIssues
22nd Sep 2010 08:47

Self employed tax gap

" ... the self employed percentages are based on a mathematical model using the results of random enquiries over the period 1999 to 2007 ......  I was shocked that the percentage is that high, and it gives me pause to think about why some officers come at enquiries thinking everyone is fiddling."

The percentage is high because I do not think that HMRC "do" random enquires. Enquiries are targetted based on their (flawed) determination criteria and thus will result in a higher rate. This skews the result.

"As to simplification - I have my doubts whether simpler would reduce the tax gap...."

HMRC have been allowed to to develop a tax system that is so complex and so open to interpretation that no-one - and I mean absolutley no-one - can agree on what the correct tax should be. This also makes the results worthless as actual tax in this context is what HMRC deem it to be. As they generally go unchallenged they deem themselves to be right. Skewed results yet again. I use the PCG's IR35 figures once again. If the accountancy profession had fought IR35 status at tribunal as the PCG did, the existing loss on IR35 returns would have been ten fold. Skewed results yet again.

This concept ought to be rammed down their throats. Judges, lawyers, tax accountants, accountants, finance directors, tax inspectors, financial advisors, HMRC drones and company directors cannot agree on what tax is payable, never mind the general public who may or may not have had a mathematical or legalese education of some form.

Based on a complex tax system and skewed results, they have no right to persecute the public for tax money or make moral judgements on legal behaviour in terms of avoidance until they have simplified the system.

"One thing I am certain of is that the OTS (Office of Tax simplification) has its work cut out and I have grave doubts whether we shall see the sort of change lobbied for here..... when politics gets involved (as inevitably it will) the ability (and eventually the enthusiasm) to make radical change will be stifled."

All I'm going to say is ..... watch this space.

 

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By mikewhit
23rd Sep 2010 12:22

Methodology please !

Yes, "results of random enquiries" does really need some kind of qualification.

For example, were the enquiry subjects chosen:

by a random processbased on UTRbased on PAYE referenceby size of businesswith reference to amount of turnoverby regionby industry sectorby employment category

and the answer(s) given to the above then determine the limits of validity of the result.

For example, if chosen randomly by PAYE reference, you automatically could not get two people from the same company.

Otherwise it's as bad as quoting homeopathic (diluted!)snake-oil salesmen saying their cold treatment works because everyone got better in the end ...

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