Summary
HM Revenue & Customs’ (HMRC’s) most recent estimate of the tax gap, the difference between tax owed and tax that is actually paid, was £31 billion in 2018–19.
Although HMRC recognises that there is significant uncertainty associated with its estimates of the tax gap, it continues to quote these figures in official reports and media releases in a way that suggests a much greater degree of precision. We therefore call on HMRC to publish the range of its estimate of the tax gap, rather than suggest there is a single figure. We also recognise the challenges for the taxpayer and HMRC during the COVID-19 pandemic with HMRC currently estimating up to 10% fraud or error in furlough claims. Compliance yield (the additional tax revenue directly attributable to HMRC’s work) is down by about half in the first quarter of this year. HMRC is not yet able to assess fully the impact of the COVID-19 pandemic on its compliance approach. However, it is clear that HMRC now needs to think fundamentally about how it collects unpaid tax.
Early indications show compliance yield in the first quarter of 2020–21 is only half the amount HMRC reported in the same period last year. Understandably, HMRC has carried out fewer investigations since the lockdown began in March, as it had to prioritise the implementation of the COVID-19 support schemes and be responsive to the needs of taxpayers struggling with the impacts of the pandemic. The number of completed civil compliance checks fell from 62,000 in the first quarter of 2019–20 to 40,000 in the first quarter of 2020–21. HMRC may never catch up and it will inevitably have to change its approach to compliance because of COVID-19. For example, it has a large backlog of cases and there is significant fraud and error in the furlough scheme. It is very worrying that HMRC estimates up to £3.5 billion of furlough payments made by 16 August 2020 may have been fraudulent or paid in error.
HMRC publishes a detailed tax gap analysis but is unable to provide a detailed breakdown in some important areas, such as the tax gaps for the four nations of the UK. HMRC’s analysis also fails to set out the relative size of the tax gap for different sectors of the economy and does not include legal but undesirable tax planning by the wealthy and large businesses.
The tax gap has a wide range of causes, ranging from deliberate evasion to accidental taxpayer error. Small businesses are responsible for more than 40% of the tax gap, followed by large business with 17%. Wealthy taxpayers, which HMRC classifies as people earning more than £200,000 a year, or holding assets of more than £2 million, account for 6% of the tax gap. HMRC claims success in tackling the tax gap but its estimates are simply not reliable enough to make such definitive claims. For example, in July 2020, HMRC made substantial revisions to its previous estimates of the tax gap as new and updated data became available. These large revisions reversed past trends reported by HMRC, highlighting the uncertainties associated with the tax gap estimates and the difficulty of using them to track performance.
We reported in July that, despite a pandemic being a top national risk for years, lack of thinking about its economic impacts had forced the government to design the support schemes from scratch. With at least some thinking about the economic risks of a pandemic in advance, it may have been possible to build in stronger safeguards against fraud and error, while still providing much-needed support to businesses and their employees. HMRC relies heavily on taxpayers’ ability and willingness to report and pay their taxes in line with the rules. This may have changed—in the short term and possibly for several years to come. More than ever, therefore, HMRC needs to consider the support customers need and the costs it imposes on taxpayers, particularly as it proceeds with plans to make tax digital, where there are indications that the costs imposed on taxpayers far exceed government estimates.
Published: 16 October 2020