Tax Avoidance and the Tax Gap – an explainer

This explainer is part of a series produced by CIOT for the 2024 general election.

You can also watch our video explainer.

Important: Some numbers in this explainer were updated on 25 June to take account of new tax gap figures published on 20 June. We commented on these new figures here.  

It’s election time, and politicians are searching for pots of money that can be used to fund spending priorities and tax giveaways.

Labour, the Conservatives and the Lib Dems think there are billions of pounds in uncollected tax that, with a bit of effort, could be brought in by HM Revenue and Customs, the UK’s tax authority. Are they right?

The explainer

So what are the parties saying?
(this answer updated 11 June following publication of the Conservative and Lib Dems manifestos)

Labour say they can raise an extra £5 billion a year for health services and schools by ‘cracking down on tax dodgers’. They set out how they would go about this in a paper published in April called ‘Labour’s plan to close the tax gap’. There are three elements to the plan – as well as ‘boosting compliance activities’ they would ‘invest in technology transformation’ and make changes to the law. (The paper provides more detail.)

The £5 billion, by the way, is a net figure. They would spend just under £1 billion a year on HMRC staffing and technology to deliver (they project) an increase of £6 billion in the tax take. This is by the end of the Parliament. It would ramp up from a £700 million net gain in year one.

The Conservative manifesto includes plans to “raise at least a further £6 billion a year from tackling tax avoidance and evasion by the end of the Parliament”. Proposed measures set out in a costings document include “hiring additional HMRC staff, investing in labour-saving technology such as AI, and focusing particularly on problem issues like umbrella companies and regulation of the tax advice market”.

The Lib Dems also have plans funded by tackling avoidance and evasion, for example boosting spending on public health by £1 billion a year. Their manifesto costings document states they would: “Narrow the £36 billion annual tax gap by investing an extra £1 billion a year in HMRC to improve customer support and boost compliance and anti-avoidance activities.” They anticipate bringing in an extra £7.23 billion a year by the final year of the next Parliament.

Billions in uncollected tax… that sounds too good to be true?

Obviously it’s not deliberately uncollected. But yes, according to the government’s own estimates there is nearly £40 billion a year of tax that should be collected but is not being collected. This is commonly referred to as the ‘tax gap’.

Is this tax avoidance?

£1.8 billion of it is, according to HMRC.

A much bigger share is illegal activity. Tax evasion, criminal attacks and ‘the hidden economy’ are thought to add up to more than £11 billion a year. (The ‘hidden economy’, in case you’re wondering, is economic activity hidden from HMRC, such as a business that hasn’t registered for tax.)

But there is more to the tax gap than avoidance and illegality,

A £5 billion chunk of the tax gap comes from debts being written off by HMRC and a further £4 billion comes from the dubious category of ‘legal interpretation’ which is tax which HMRC think is legally due but the system is so complex the taxpayer and HMRC can’t agree!

But the biggest part of the tax gap – nearly £18 billion of it – comes from taxpayers’ mistakes – what HMRC categorise as error and carelessness.

When the politicians talk about ‘tackling avoidance’ or ‘avoidance and evasion’ are they using this as shorthand for reducing the tax gap as a whole?
(this answer updated 11 June following publication of the Conservative and Lib Dems manifestos)

It appears so. For Labour, while it is presented on the party’s website under the heading ‘How Labour will clamp down on tax avoidance’ the party’s ‘plan to close the tax gap’ includes measures aimed at reducing error and carelessness as well as avoidance and illegality. Similarly the Lib Dems, while providing less detail, refer to, and are clearly aiming at, the wider tax gap.

It’s less easy to be sure with the Conservatives. The manifesto only refers to tackling avoidance and evasion but the separate costings document records the additional revenue under the heading ‘Tackling Tax Gap’.

Given that the current tax gap for avoidance is £1.8 billion and for evasion is £5.5 billion it seems probable that all the parties are casting their net wider for the £6 billion of extra revenue rather than assuming they can virtually eliminate both these behaviours.

What’s the basis for them saying they can raise an extra £6 billion a year?

Both Labour and the Conservatives point to remarks by Gareth Davies, the head of the National Audit Office, the government’s spending watchdog, in an interview with the Financial Times in January 2024. The paper quotes Davies as saying, “We think that our work demonstrates that there are tens of billions of savings available a year”, and adds (not in direct quote marks) that these include ‘£6bn in cracking down on tax evasion and avoidance’.

Additionally both Davies (in his report accompanying HMRC’s 2022-23 accounts) and Labour (in their tax gap plan) have noted the fall in HMRC compliance yield (the revenue generated from their tax compliance activities during the pandemic) from 5.6% of total tax due in 2019-20 to 4.2% in 2022-23. If this fall could be reversed it would more than raise the £6 billion being targeted – probably more than twice that amount.

What does history tell us about the record of past governments at reducing the tax gap?

They’ve not done too badly.

In cash terms the tax gap has remained relatively steady over the years (broadly £30-36 billion before tipping up a bit in the last couple of years) since it was first calculated nearly 20 years ago. But the better measure is as a share of the total theoretical tax liability - that is, what HMRC think they would bring in if everyone was perfectly compliant. This has fallen by about a third – from 7.4 per cent of total liability in 2005-6 to 4.8 per cent in 2022-23 (the latest figures we have).

The numbers need to be treated with some caution as how the tax gap is calculated has changed over the years – and calculating the tax gap is in any case a less than perfect science – but they are the best we have so let’s stick with them.

Which areas have past governments done best at?

The biggest percentage fall is in avoidance. Back in 2005-6 it is reckoned that £11 in every £1,000 of tax was avoided. That’s since been cut to £2. This fall has taken place under governments of all political colours. Significant measures in achieving this included the Disclosure of Tax Avoidance Schemes regime, introduced in 2004 but gradually expanded over the years, as well as the General Anti-Abuse Rule (introduced in 2013), accelerated payment notices and follower notices (both introduced in 2014). Alongside changes to the law there have also been big changes in public attitudes – seemingly driven by a combination of the financial crisis and various media exposés – which have increased the reputational risk of engaging in tax avoidance.

Past governments have also done well at tackling illegal activity. Back in 2005-6 it’s thought £31 in every £1,000 of tax was lost to illegal activity (£16 to criminal attacks, £10 to tax evasion and £5 to the hidden economy). In 2022-23 this was down to £14 (£4 to criminal attacks, £7 to evasion and £3 to the hidden economy). A significant factor in this is likely to have been the introduction of HMRC’s Connect system – sophisticated software used for data matching and risking – in 2010. HMRC also now receive large amounts of data about UK taxpayers which helps them target their compliance activity, for example offshore data they receive under international exchange of information agreements like the Common Reporting Standard which started in 2017-18.

Are there areas where they’ve been unsuccessful?

Estimated tax loss due to taxpayer error and carelessness has risen in recent years. Taxpayer error fell from £7 in every £1,000 in 2005-6 to £5 in every £1,000 before rising again to £7 in every £1,000 in the latest figures. Its close cousin, taxpayer carelessness, fell from £11 in every £1,000 to £9 in every £1,000 before rising to £15 in every £1,000 in the latest estimate.

Why has this happened? Changes in how the tax gap is calculated may be one factor, but increasing complexity of the tax system, deterioration in HMRC customer service and inadequacy of published guidance may also have played a part.

We suggest considering error and carelessness as a whole (‘mistakes’) as it is HMRC who decide whether a taxpayer has taken reasonable care – itself an area of potential controversy. As other components of the tax gap have dropped, this area has come to make up a larger share of the lost revenue – 45 per cent now compared to 23 per cent back in 2005-6.

So, can the tax gap be reduced further?

Probably – though the law of diminishing returns may mean further marginal gains are becoming harder to come by. Ambitious targets are to be applauded but our advice to politicians of all parties is not to spend the money before it’s been collected.

How would you reduce it?

Thanks for asking.

As noted above almost half the tax gap (£18 billion) is now taxpayer mistakes (error and carelessness). The next government should:

• Help wannabe-compliant taxpayers to be compliant by investing in HMRC customer service so they can get answers to their queries
• Focus on simplification – a simpler tax system, with clear rules and easy to navigate guidance would lead to fewer mistakes by both taxpayers and tax authorities
• Invest in digitalising the tax system but review the process to focus it more on the needs of taxpayers

Illegal activity is another £11 billion. While efforts in the early 2010s to put extra resources into identifying and tackling tax evasion and other illegal activity were successful HMRC now need to think more imaginatively and make effective use of the latest techniques for spotting and tackling criminal activity, including continuing to invest in data analytics. This area may get a boost next year when HMRC get access for the first time to large amounts of data from online digital platforms, which could reveal that many people who trade on these platforms have not been reporting their income to HMRC.

Further information on the tax gap

What is the tax gap? 

The tax gap is the difference between the amount of tax that should, in theory, be paid to HMRC each year, and what is actually paid. It includes all taxes within HMRC’s administration and collection powers, but not the devolved taxes which are administered and collected by the devolved tax authorities, nor estimates of error and fraud in research and development tax reliefs. 

How big is the tax gap? 

In 2022-23, the latest published figures, the tax gap was £39.8 billion. This represents 4.8% of total theoretical tax liabilities ie the total amount that was due to HMRC in that year. 

Figures quoted below are from 2022-23, unless otherwise stated.

Why do HMRC calculate the tax gap? 

The tax gap provides HMRC with a useful tool for understanding the relative size and nature of tax non-compliance. They use this understanding to address the causes of non-compliance, see what measures are helping reduce the tax gap, see how tax administration can be improved, as well as providing an indicator as to how well they are performing. 

The tax gap also provides important information to the public on tax compliance, creating greater transparency and trust in the tax system. 

How is the tax gap calculated? 

Calculating the tax gap is a mixture of art and science. VAT and excise duty gaps are mainly estimated using a ‘top-down’ approach, by comparing the implied tax due from consumer expenditure data with tax receipts. Most other components are estimated using a ‘bottom-up’ approach, based on HMRC’s operational data and management information such as random enquiry data and statistical methods. 

What makes up the tax gap? 

HMRC provide several different analyses of the tax gap: 

1. By type of tax 
2. By ‘customer’ group 
3. By behaviour 

1. By type of tax 

HMRC breaks down the tax gap between the following groups of taxes: 

Type of tax	Tax gap £bn
Income Tax, National Insurance contributions and Capital Gains Tax	13.7
Corporation Tax	13.7
VAT	8.1
Excise duties, such as on tobacco and alcohol	2.5
Other taxes	1.8
Total	39.8

 2. By ‘customer’ group 

HMRC analyses the tax gap between different types of taxpayer or ‘customer’: 

Nature of taxpayer	Tax gap £bn
Small businesses  Defined as having a turnover below £10 million and typically fewer than 20 employees.   Small businesses represent more than 95% of businesses in UK – there are around 5.3 million of them.	24.1
Mid-sized businesses  Defined as having a turnover between £10 million and £200 million, or typically 20 or more employees.   Mid-sized businesses make up less than 5% of UK businesses – there are around 270,000 of them.	4.2
Large businesses  Defined as having a turnover exceeding £200 million or £2 billion in assets.  Large businesses represent around 2,000 of the largest and most complex businesses.	4.3
Individuals  Defined as having incomes below £200,000 and assets below £2 million in each of the last 3 years.   Around 32 million people liable to pay tax through PAYE and 7 million through Self Assessment.	1.9
Wealthy individuals  Defined as having incomes of £200,000 or more, or assets equal to or above £2 million in any of the last 3 years.   There are around 800,000 wealthy individuals.	1.9
Criminals  [not defined by HMRC]	3.5
Total	39.8

 As these figures illustrate, HMRC believe that well over half of the tax gap is attributable to small businesses.  

3. By behaviour 

HMRC analyses the tax gap between different behaviours which, in their view, cause the non-payment of taxes they consider due: 

Nature of behaviour	Tax gap £bn
Failure to take reasonable care  Defined as “carelessness and/or negligence in adequately recording their transactions and/or in preparing their tax returns”.	12.0
Error  Defined as “mistakes made in preparing tax calculations, completing returns or in supplying other relevant information, despite the customer taking reasonable care”.	5.8
Legal interpretation  Defined as “where the customer’s and HMRC’s interpretation of the law and how it applies to the facts in a particular case result in a different tax outcome, and there is no avoidance”.	3.9
Criminal attacks  Defined as when “organised criminal groups undertake co-ordinated and systematic attacks on the tax system”.	3.5
Evasion  Defined as “illegal activity where registered individuals or businesses deliberately omit, conceal or misrepresent information in order to reduce their tax liabilities”.	5.5
Hidden economy  Defined as “sources of taxable economic activity that are entirely hidden from HMRC”.	2.2
Avoidance  Defined as “bending the tax rules to try to gain a tax advantage that Parliament never intended. It often involves contrived, artificial transactions that serve little or no purpose other than to produce a tax advantage. It involves operating within the letter but not the spirit of the law”.	1.8
Non-payment  Defined as “debts that are written off by HMRC and result in a permanent loss of tax” [direct tax] and “the difference between new debts arising and debt payments” [VAT].	5.2
Total	39.8

Further grouping of these behaviours indicates that: 

• ‘Mistakes’ represent £17.8bn, or 45% of the tax gap 
• Illegal behaviour represents £11.2bn, or 25% of the tax gap 

Is the tax gap accurate? 

HMRC say that their tax gap estimates are official statistics produced to the highest levels of quality and that they are adhere to the UK Statistics Authority’s Code of Practice for Statistics framework which ensures statistics are trustworthy, good quality, valuable and provide producers of official statistics with the detailed practices they must commit to when producing and releasing official statistics. 

That said, there are a range of factors that can affect their accuracy and robustness. HMRC evaluate the uncertainty of their tax gap estimates by assigning an uncertainty rating, ranging from ‘very low’ to ‘very high’, to several components of the tax gap.  

Because of the inherent uncertainties and assumptions used in calculating the tax gap, it is better to look at the size and components of the tax gap over a period of time, rather than an annual snapshot.  

Where can I find further information? 

The latest published figures are for 2022-23 and can be found at https://www.gov.uk/government/collections/measuring-tax-gaps. The tax gap figures tend to be published each summer. The latest figures were published 20 June 2024.

More information on the tax gap uncertainty assessment can be found in the ‘Methodological annex’. 

This explainer was written by:
Richard Wild, Head of Tax Technical, Chartered Institute of Taxation
George Crozier, Head of External Relations, Chartered Institute of Taxation

Originally published 7 June 2024, updated 11 June 2024 and 25 June 2024