National Audit Office Value for Money Report: Executive Summary
Tackling the hidden economy
Summary
- The hidden economy is usually taken to mean any
undeclared economic activity. Definitions vary, but it
can range from casual moonlighting, work paid cash in
hand, fraudulently claiming welfare benefits, through
to tax evasion and organised crime. We reported in
January 2008 on the Department for Work and Pensions’
progress in tackling benefit fraud. This report focuses
on HM Revenue & Customs’ (the Department) work in
tackling the hidden economy, covering four groups:
- businesses that should be registered to pay tax, such as VAT, but are
not;
- people who work in the hidden economy and pay no tax at all on their
earnings (ghosts);
- people who pay tax on some earnings but fail to declare other additional
sources of income (moonlighters); and,
- employers who may facilitate ghosts and moonlighters, and also evade
employers’ National Insurance contributions.
It excludes the Department’s work in relation to under
declarations of income by registered taxpayers as these
risks are dealt with by the Department’s mainstream
compliance teams. We use the term “hidden economy”
to refer to the above four groups throughout this report.
- The report examines:
- the Department’s approach to tackling the hidden
economy (Part 1);
- how the Department encourages people and
businesses into the formal economy (Part 2);
- how the Department detects people and businesses
in the hidden economy (Part 3);
- the sanctions the Department imposes (Part 4); and
- how the Department manages the risks to tax from
the hidden economy (Part 5).
- Appendix 1 provides details of our methodology.
The risks from the hidden economy
- In common with other tax authorities, HM Revenue
& Customs has sought to estimate the amount of tax
lost from the hidden economy, but so far no one has
been able to produce robust estimates. In 2002 the
Department published estimates of VAT losses of between
£400 million and £500 million from between 125,000 and
180,000 businesses that should have been VAT registered
but were not. Since that time the Department has continued
to work on ways of estimating the amount of tax lost. For
other taxes, the Department estimated in 2005 that using
certain assumptions there were some two million ghosts
and moonlighters with losses of at least £1.5 billion. The
Department is using new computer software to help assess
the risks from the hidden economy by comparing tax
records with a number of external data sources. It expects
regular comparisons between these records to provide
it with better information on the extent of the hidden
economy and trends within it. In 2008 the European
Commission intends to undertake a study to identify the
best methodology for providing comparable estimates of
the amount of undeclared work across the EU.
- The Department currently assesses the risks from
the hidden economy by drawing on various sources
of information including the experience of its hidden
economy teams, assessing whether the risks identified by
other tax authorities could also apply to the UK, making
greater use of data matching techniques, considering
whether information from academic research provides
insights into the sectors it could tackle and reports by the
public to its hotline of those suspected of operating in the
hidden economy. For example the Department’s experience
shows that self-employed people are the most likely group
to be operating in the hidden economy, especially where
cash is commonly used for payment. The results of the
hotline also show new risks to tax revenue emerging from
those trading on the internet and from buy-to-let landlords
failing to declare their income and capital gains.
Encouraging people and businesses
into the formal economy
- The Department achieved an overall return of
around 4.5:1 on the £41 million a year it spent on all
of its hidden economy work in 2006-07. As part of the
Department’s wider tax compliance approach, it has
been developing specific risk-led campaigns using new
targeted ways of encouraging people into the formal
economy. These campaigns have led to much higher
returns which provide lessons for the future. Advertising
campaigns have resulted in some 8,300 additional people
registering to pay tax who may otherwise have joined
or remained in the hidden economy. The Department
estimates that they will pay tax of around £38 million over
three years providing a return of 19:1 on the expenditure
of £2 million. Building on this success, the Department
could make more use of advertising to inform people
of the benefits of working in the formal economy and
make clearer what is likely to happen to them if they
come forward voluntarily. Some are concerned whether
they can afford to pay the tax owed not realising that
the Department will allow time to pay. The European
Commission has identified opportunities for Member
States to make more use of advertising campaigns to
highlight to the public the risks of employing people in the
hidden economy. In Canada, the tax authority has run a
national advertising campaign to inform the public of the
risks in dealing with home repair contractors operating in
the hidden economy and the Department has undertaken
some similar campaigns.
- The Department has successfully used voluntary
disclosure arrangements to encourage people to declare
tax owed. In 2006 and 2007 the Department won
landmark rulings against a variety of major financial
institutions that required them to disclose the details
of offshore bank accounts held by UK residents. As
a result the Department received details of around
400,000 bank accounts from which it estimated that up
to 100,000 people should have included income and/or
the resulting interest from those accounts on their tax
returns but had not. It recently introduced the Offshore
Disclosure arrangements to encourage these people
to come forward voluntarily, disclose and pay all tax
owed. By the 22 June 2007 closing date of the scheme,
the Department had received 64,000 notifications and
around 45,000 people came forward to disclose under the
arrangements bringing in around £400 million at a cost of
£6 million or a return of 67:1.
Detection and sanctions
- Since 2003-04 the number of cases detected by
the Department’s hidden economy teams each year
has fluctuated between a high of 32,700 [Footnote 1] and a low
of 28,300 in 2006-07. The number of cases was
12 per cent lower in 2006-07 than in 2003-04,
mainly because the Department’s teams appear to
have concentrated on identifying and targeting higher
value cases. Over the four year period to 2006-07, the
amount of tax detected has increased by 13 per cent in
real terms to £145 million. To increase detections, the
Department set up the Tax Evasion hotline in 2005 to
allow members of the public to report suspicions of tax
evasion. It received over 100,000 calls in the first year but
progress on investigating these cases has been slower than
expected with around 2,000 investigations completed
in 2006-07 compared with 5,500 planned. The total tax
assessed in 2006-07 has also been much lower than
expected at £2.6 million compared to original estimates
of £32.5 million. The Department’s original assumptions
have proved to be incorrect with additional effort needed
to handle three times more calls than expected and
evaluate the information received. More of the information
than expected has been of insufficient quality to help
with detecting someone working in the hidden economy.
To deal with cases more quickly, the Department is now
using automated methods to compare the information
received with tax records and other external data sources
as a way of determining whether tax may be owed.
- The Department has also been making more use
of data matching techniques to detect people in the
hidden economy. In a pilot project, the Department used
specialist computer software to analyse various internal
and external information sources which initially identified
over 300,000 potential cases. The Department is testing
the accuracy of the information and refining its approach,
and plans to conduct further work in 2008-09 on up
to 20,000 cases, with a potential value of £26 million
in additional yield. This work is experimental and is at
an early stage of development. The lessons from this
work will help the Department identify cases with more
certainty in the future. There may be other opportunities
to data match tax records against other large external
data sources holding information for example on
landlords and the self-employed in the home repair and
maintenance sector.
- Where people are detected in the hidden
economy, the Department can impose a civil penalty
of up to 100 per cent of the tax owed but in most cases
it is much lower. It is examining whether to impose the
maximum penalties in more serious cases. The number of
hidden economy cases prosecuted increased to around
70 cases in 2006-07, which cost on average £30,000,
exceeding the average amount of tax detected at £11,260.
The Department did not receive much publicity on these
cases thereby reducing their wider deterrent effect.
It closed 284 cases in 2006-07 because there was either
insufficient evidence to refer the case for prosecution, little
tax at risk or further investigation of the case would not be
in the public interest. Overall the turnover in completing
cases appears to be slowing down. The Department
completed investigations on 353 cases during 2006-07.
The number of new cases opened during the year (290)
was less than this level, while 335 cases were carried
forward to 2007-08.
Conclusions and recommendations
- In the absence of robust estimates of the size of the
hidden economy, it is difficult to assess the overall effect
of the Department’s activities on reducing the amount of
tax being lost. Nevertheless it has made improvements
in response to previous reports by the NAO and the
Committee of Public Accounts and developed its methods.
As a result the Department appears to be more effective,
having achieved some success with new advertising and
disclosure campaigns to encourage people to regularise
their tax affairs, and the number of hidden economy cases
prosecuted has increased. The Department’s work also
compares well in many areas with other tax authorities.
- The Department achieved a return of around 4.5:1 on the £41 million a year
it spent on all of its hidden economy work in 2006-07, and this should increase
as more recent initiatives achieve their full effect. Nevertheless, the risk of
being detected and the consequent penalties for non-compliance are relatively
low, and there are opportunities to tackle the hidden economy more effectively.
The relatively high returns achieved from the Offshore Disclosure arrangements
indicate that the Department should combine more extensive data matching with a
programme of targeted advertising campaigns in risk areas such as the home
repair, maintenance and improvement sector to encourage people into the formal
economy. It could also seek to change public attitudes to help reduce demand for
hidden economy work and its social acceptability by building on its previous
campaigns that highlighted risks to the public of employing those operating in
the hidden economy. There are also opportunities to mount a more effective
deterrence, by making fuller use of the penalties available, and securing more
publicity for successful prosecutions.
- Our analysis suggests that the Department has been successful in using new
methods to encourage large numbers of people into the formal economy relatively
quickly, while still penalising them for their dishonesty. Such methods have
enabled the Department to make higher returns than from its civil and criminal
investigations. As the Department identifies opportunities to make further use
of these new methods it will need to reappraise how it deploys its resources to
best effect between this type of work and more formal investigations. In so
doing it will need to have regard to maintaining a balanced programme of
prevention, detection and deterrence and be mindful of the wider public interest
in prosecuting significant dishonest conduct.
- In this context we recommend that the Department should take the following
steps:
- In common with other tax authorities the Department does not have
robust estimates of the tax lost from the hidden economy. It has been
developing its understanding of the risks to tax for different sectors
and groups but it should bring the information together in a structured
way to produce a firmer estimate of tax lost, identify the areas of
highest risk and gaps in coverage where further analysis is needed. A
firmer estimate of the tax lost would help the Department judge the
scale of the challenge, how it is changing over time and whether it is
doing enough to tackle the problem.
- The Department has obtained good returns from the Offshore
Disclosure arrangements. It should devise similar schemes in other
sectors to secure widespread voluntary disclosure. Such schemes would
involve obtaining information through data matching or other sources on
groups of potentially non-compliant people or businesses and using that
information to contact those who should consider taking advantage of the
schemes. Sectors where the Department could test this approach are home
repair, maintenance and improvement and landlords where the risks of
people/businesses operating in the hidden economy are high.
- The Department has had some success in using publicity to encourage
people into the formal economy. There are opportunities to make more
extensive use of publicity to raise awareness of the benefits of joining
the formal economy and how to do this, and to change public attitudes
about the social acceptability of employing people who work in the
hidden economy. The Department should:
- Periodically remind people of their responsibilities to
register as self-employed, building on the success of recent
campaigns.
- Advertise the advantages of joining the formal economy such
as pointing out to those in the hidden economy that it would
increase their credibility as business people and open up
business opportunities.
- Advertise more widely the help it provides to people on
putting their tax affairs in order including that it will accept
payments by instalments.
- Use publicity to encourage high take-up of further voluntary
disclosure schemes.
- Make more widely known the action it will take where it
detects people in the hidden economy. Some people in the hidden
economy believe that the Department will seek a prosecution in
every case, which discourages them from coming forward.
- Publicise more widely the outcome of prosecution cases to
increase their deterrent effect.
- Launch further campaigns to change attitudes about employing
people in the hidden economy particularly in the home repair and
maintenance sector where it could build on its previous campaign.
- The Department obtains higher returns from detecting certain types
of cases such as businesses not registered for VAT, employer compliance
cases and small businesses. It should concentrate more detection work on
cases where the overall return is higher.
- The Department’s hidden economy teams do not always provide feedback
on the usefulness of the information provided by other teams within the
Department and public sector bodies which refer suspicious cases for
further investigation. The Department should provide feedback to help
these teams understand the type of information that is useful in
detecting cases.
- In some of the cases detected by the Department, businesses have
kept poor financial records making it difficult to assess the correct
amount of tax due. The Department should:
- Send warning letters more routinely to those detected who
have not kept adequate financial records, particularly where
they present a significant risk to tax.
- Provide them with information on where they can obtain help,
and the penalties they could face. This help could include
providing suitable software free of charge.
- Use planned reviews of the records businesses keep to follow
up on cases where it has found businesses have kept poor records
in the past.
- [back] The number of
cases detected in 2005-06.
