The tax gap – why have HM Revenue & Customs got it so wrong, and what should be done about it now?

Posted on

On June 16 a debate took place in parliament on the UK tax gap. Initiated by Lib Dem MP John Pugh a number of speakers referred to my work, for which I ma grateful.

The the Conservative Exchequer Secretary, representing the government spoke, and dealt with my work at length. His thoughts can be summarised in the following paragraphs:

The Hon. Member for Southport mentioned the £120 billion estimate, although he did not necessarily say that he thought it was right. It is mentioned frequently among hon. Members and in the media. That figure was produced by the Tax Justice Network, or Tax Research LLP, which is essentially the same organisation. It is a striking figure, and is often repeated. It is very different from the £40 billion estimated by HMRC. The £120 billion figure has clearly focused attention on the matter, and that is no bad thing, but scepticism about it is widespread; indeed, I expressed some scepticism myself from the Opposition Benches a year or so ago. Given the disparity between the £120 billion and HMRC's numbers, I have asked officials to review it.

It must be accepted that in preparing estimates, organisations external to Government have access to much less data than HMRC. The types of methodology available to them are therefore restricted. It is reasonable to assume that HMRC is clearly in a better position to make an assessment, but there is no reason why outside bodies should not contribute to the debate. However, having considered the methodology used to produce the figure of £120 billion, I must tell the House that even a brief analysis reveals that it is deeply and systematically flawed.

I think it only fair I recognise ministerial criticism of my work.

I have also to say, quite emphatically, that the minister is wrong. I do not say so as a knee-jerk reaction. One reason for delaying my response has been the need to go back and check my facts. That I have done. This morning I am publishing my response to the minister, here. I will also be publishing a number of further blogs highlighting particular flaws in the HMRC estimates of the tax gap on which the minister bases his claim, but for the moment the executive summary of my response says:

This briefing considers criticisms made of the work of Tax Research UK in estimating the nature and extent of the UK tax gap.

The UK tax gap has three components: tax recognised by taxpayers to be due but paid late or not at all; tax illegally evaded by those who should pay it and tax avoided as a result of the exploitation of loopholes in tax law not anticipated by the UK tax authorities.

It has been claimed by HM Revenue & Customs that these sums when combined total not more than £40 billion per annum and this sum was defended in a parliamentary debate by Exchequer Secretary David Gauke MP on June 16 2010.

Tax Research UK has estimated the tax gap to be at least £120 billion at any point in time at present and has used this estimate as the basis for a claim that addressing this issue could, by itself, do much to close the current UK government financial deficit[i].

Given the disparity in these estimates it seems clear one estimate has to be more accurate than the other, always noting that absolute accuracy in these matters is impossible: by definition taxpayers choose not to disclose the contribution they seek to make to the tax gap. This paper argues that the Tax Research UK estimate is, on the basis of reasoned analysis and research, highly likely to be considerably more accurate than the estimate made by HM Revenue & Customs.

Firstly, the Tax Research UK estimate for tax paid late or not at all is not an estimate: it is a statement of fact made by HM Revenue & Customs in evidence to the Parliamentary Accounts Committee in 2009. It could only be wrong if tax paid late is not a part of the tax gap. HM Revenue & Customs documentation showing that tax paid late is part of the tax gap is included in this report. The HM Revenue & Customs say this gap is, despite that, just £1.8 billion. The Ministerial claim is that this figure should only be considered to be £3 billion. Curiously they do not agree. Both seem to be considerably wide of the mark.

Second, with regard to personal tax avoidance this briefing shows that the claim by HM Revenue & Customs that there is just £1.1 billion of tax avoidance spread over income tax, national insurance and capital gains tax combined is very obviously wrong. Indeed, in his budget speech in 2010 George Osborne straightforwardly contradicted that HM Revenue & Customs claim when saying that tax avoidance with regard to capital gains tax alone exceeded £1 billion, happening in the process to exactly confirm the estimate of avoidance with regard to that particular tax made by Tax Research UK. The Exchequer Secretary also contradicted HM Revenue & Customs’ claims in his speech on 16 June: it is very clear neither minister has any faith in the HM Revenue & Customs estimate whilst that of Tax Research UK appears to accord with the Chancellor’s estimate. As such the Tax Research UK figure is considered confirmed until evidence to the contrary is presented.

It is however accepted in this briefing that current evidence does suggest more work is needed to support the Tax Research UK figure for tax avoidance by companies of £12 billion. This is not to say that estimate is wrong; it does say more evidence is now available which strongly suggest that the figure for such tax avoidance cannot be as low as that claimed by HM Revenue & Customs, amounting to a sum of just £3.4 billion because the new evidence now available suggests that the tax gap for corporation tax would appear to exceed £7 billion at present. More research on this will be published in the autumn of 2010.

Tellingly, the difference arising between the new evidence and the 2008 TUC estimate prepared by Tax Research UK appears to relate to small companies and not big companies. With regard to large companies the TUC estimate that those companies pay tax at an effective rate approximately 8% less than might reasonably be anticipated has been confirmed by new HMRC data. What is surprising is that this tax gap does not extrapolate to small companies: they are paying tax at almost the full expected tax rate according to HMRC data, virtually eliminating the policy driven differential between large and small company tax rates. It is in this area that more work is now needed because if this is true then further planned changes in corporation tax rates for large companies announced in the first coalition government budget will mean large companies will soon be enjoying the lowest effective tax rates in the UK, and will be paying tax at lower rates than smaller businesses. This is an issue of real importance to the UK and its tax gap, if true.

Finally, the report considers the claim by HM Revenue & Customs that tax evasion does not exceed £33.5 billion a year or about 6.5% of the total tax base. Tax Research UK suggests that, based on the average VAT gap of about 13.7% the tax gap due to evasion is not less than £70 billion per annum. This report robustly defends the use of Tax Research UK’s methodology. It also points out that academic estimates of the shadow economy in the UK fall in a range from about 12.5% to about 16% - in the middle of which the Tax Research UK estimate for tax evasion (fuelled by the shadow economy) falls. The HM Revenue & Customs claim is, in this case, outside all expected outcomes for such an estimate and is therefore highly likely to be incorrect.

Based on this evidence the Tax Research UK claim that the tax gap is likely to be in the order of £120 billion at any point in time is considered justified. As such the policy recommendations based on this estimate are also considered justified.

That said, this conclusion does not end this debate. As this briefing notes, such a conclusion does instead give rise to the following questions:

1. Why isn’t this tax gap being acknowledged by HM Revenue & Customs and Ministers?

2. Why did HMRC so very obviously understate their estimates so significantly?

3. What is now going to be done to ensure accurate estimates of the tax gap are prepared?

4. Given the problems that clearly exist in relying upon HM Revenue & Customs and HM Treasury to estimate the tax gap can we have an Office for Tax Responsibility to ensure that proper tax estimates are prepared and that credible plans to close the tax gap are put in place?

5. When will adequate resources to tackle the tax gap be allocated to HMRC? This would include cancelling the current HM Revenue & Customs office closure programme and reinstating sacked staff whose services are essential if the tax gap is to be closed.

6. Why wasn’t closing the tax gap the focus of government attention in its plans to cut the deficit, and given the size of potential revenue available from doing so, how can cuts in public services be justified unless this issue has been tackled first?

The tax gap debate is by no means over.


[i] See http://www.financeforthefuture.com/TaxBriefing.pdf