Today the National Audit Office (NAO) reports that HM Revenue & Customs’ (HMRC’s) work to improve taxpayers’ compliance with the tax system has achieved high rates of return.
HMRC estimates the tax gap – the difference between the amount of tax the government is owed and the amount HMRC collects – has reduced from its recent peak level of 7.2% of theoretical tax owed1 in 2013-14 to 4.7% in 2018-19 (£31 billion), though there is scope to bear down further on non-compliant taxpayers. The tax gap is affected by a number of factors, including HMRC’s activity, economic conditions and changes in tax policy.
The size of the tax gap is difficult to estimate and can be revised in later years. In 2019 HMRC reported that the tax gap had increased to £35 billion or 5.6% of tax owed in 2017-18. It now estimates the tax gap reduced to £31 billion or 5.0% of tax owed in 2017-18. In other years revisions have significantly increased the tax gap from the estimate reported at the time.
HMRC faces a continual challenge to prevent the tax gap from growing because taxpayers and their advisors change their behaviour. For example, tax avoidance schemes now target more people on middle incomes than in the past.
HMRC’s latest estimates indicate most elements of the tax gap reduced between 2015-16 and 2018-19. Notable examples include reductions in the tax gap from VAT, excise duties and criminal attacks, each by at least £0.5 billion. Tax avoidance fell by an estimated 26% between 2013-14 and 2018-19 (from £2.3 billion to £1.7 billion) due to success in tackling large business tax avoidance and marketed tax avoidance schemes. Non-payment of tax liabilities, where a taxpayer is in debt to HMRC, was the only significant area to have increased (by £1 billion or 32%) between 2015-16 and 2018-19.
Each year since 2011-12, HMRC has met its targets for generating additional tax by improving taxpayers’ compliance with the system. The amount of money HMRC generated through its compliance activities increased from £23.9 billion in 2013-14 to £34.1 billion in 2018-19. However, increases to the additional tax generated through this will not necessarily reduce the tax gap, which is also affected by factors outside HMRC’s control such as economic conditions and changes in tax policy.
HMRC reports large rates of return from its compliance activities. Rates of return ranged from £7 in revenue for every £1 spent on compliance activity on individual taxpayers, to 44:1 on large business taxpayers in 2018-19. However, HMRC’s overriding consideration when allocating resources in recent years has been to maintain a sufficient level of compliance activity across all the various taxpayer groups, particularly in light of budgetary pressures. While this is important, the NAO highlights the risk that reducing resources for compliance activity in areas with high returns could disproportionately affect the tax gap.
HMRC has shifted towards earlier interventions to prevent non-compliance happening in the first place. The estimated revenue generated from this work increased from £3.2 billion in 2016-17 to £7.8 billion in 2018-19. In contrast, HMRC has reduced by a third the number of traditional enquiries and audits investigating non-complying taxpayers over the past three years. The proportion of revenue from enquiries and audits has not kept pace with increases in tax revenue overall.
HMRC is considering a range of options that could help to reduce the tax gap by modernising tax administration systems and making services simpler for taxpayers. It has developed strategies to tackle non-compliance for each taxpayer group but not for all the different types of behaviour, such as where taxpayers bend the rules or do not take reasonable care to get their tax returns right.