Sunday, February 26, 2012

Minding the Tax Gap: an overview

I've been sitting on these documents for some time, and am surprised that they haven't received more coverage,  given the extent of concern over the public finances. They are a set of papers that have been in the public domain since last September, but I do feel that they merit a better airing. They are 'Measuring Tax Gaps 2011', published by HM Revenue & Customs (HMRC) as an official statistics release.

Over the coming weeks, I intend to dip into them, highlighting some of the things that I find of particular interest., but I'm going to start today by looking at the basic figures, as calculated by HMRC over a period of years.

This, in itself, is controversial. Given that the tax gap, if filled, would either allow a reduction in the deficit, and consequential reductions in the rate of growth of government debt, or enable protection of public spending, the scale of the gap itself is hugely important. And estimates of the tax gap vary enormously, depending on how you define tax evasion, and how you perceive the value, fairness or otherwise of government 'engineering' of the tax system.

UK Uncut and the key HMRC union, the Public and Commercial Services Union, tend to quote the figure claimed by Tax Research UK - £120 billion, coincidentally very close to the estimate for the government deficit this year. This figure is made up as follows;
  • tax evasion (as suggested by the World Bank) - £70 billion
  • tax avoidance - £25 billion
  • tax paid late - £25 billion
There will be those that would question elements of this. Counting legitimate tax avoidance within the tax gap is a point to be validly argued. Is taking advantage of a government incentive to behave in a certain way wrong, in a moral sense, and if morality is part of the discussion, then is there a debate to be had on the granting of investment reliefs? Alternatively, if such reliefs encourage investment, both internally and from abroad, thus creating jobs and growth, are they merely part of government spending? I won't argue those points here.

Tax paid late is, one presumes, paid at some point, with interest. And if that £25 billion changes little year on year, is it fair to represent it as a figure that could be taken from the deficit, or from the debt? If the latter, is it really significant, or is a better figure to consider the interests paid on borrowing that amount until it is actually paid over?

So, for argument's sake, let us take the estimate as being between £70 billion and £120 billion. How does this compare to the HMRC estimate?

HMRC defines the tax gap as being:

"...the difference between tax collected and the tax that should be collected (the theoretical liability). The theoretical tax liability represents the tax that would be paid if all individuals 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 tax gap estimate is net of the Department's compliance activities. An equivalent way of defining the tax gap is the tax lost through non-payment, use of avoidance schemes, interpretation of tax effect of complex transactions, error, failure to take reasonable care, evasion, the hidden economy and organised criminal attack."

-  Chapter 1, paragraph 1, 'Measuring Tax Gaps 2011'

On that basis, HMRC estimates that the total tax gap for 2009-10 was £35 billion, approximately 8% of the estimated total tax liability for the period. And yes, there are caveats. The estimates are subject to error, due to sampling and systemic errors in assumptions - this is not entirely science (and yes, I'm a statistician by training, so I understand the irony of that statement), as the gulf between the two estimates (Tax Research UK and HMRC) demonstrates.

Again, there are legitimate questions to be asked. 'Interpretation of the intention of parliament'? Avoidance schemes? Is HMRC likely to hold its hands up to a larger tax gap given that it is responsible for restricting said gap? To its credit, it is fairly honest about the assumptions it has made, provides a vast array of data and a lengthy methodological annex, but there must still be questions asked by those who, to be blunt, know far more about this than I do?

So, in summary, there is a tax gap which is estimated as between £35 billion and £120 billion. Where it comes from, and how it might be addressed are questions that should concern all of us, and yet I sense that the debate is all about tax and spend, with very little debate of enforcement and tax policy in the round.

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