Tax gap at record high – and record low

The tax gap is the difference between the amount of tax that should, in theory, be paid to HMRC, and what is actually paid. Yesterday's HMRC report¹ looks at the estimated tax gap in 2022-23, but also revises some figures for earlier years.

The report puts the tax gap at an estimated £39.8 billion, which is 4.8 per cent of tax liabilities. This is the highest the tax gap has ever been in cash terms – up from £38.1 billion in 2021-22 – but as a percentage of the total theoretical liability it represents a fall (from 5.2% to 4.8%) to the lowest figure since the tax gap started being calculated in 2005-6. This reflects substantial increases in both the theoretical and the actual tax take since the pandemic.

Yesterday's figures mean we now have four years of data since compulsory digital record keeping and quarterly digital reporting for VAT were introduced by HMRC as the first stage of the Making Tax Digital (MTD) project. HMRC stated that this would ‘reduce the amount of tax lost to avoidable errors’. However the amount of tax lost to both error and ‘failure to take reasonable care’ has increased significantly since then, though the overall ‘VAT gap’ has fallen since MTD began (see below).

John Barnett, Chair of CIOT’s Technical Policy and Oversight Committee, said:  

“There is something for everyone in these figures. Critics of HMRC can point to a record amount – nearly £40 billion – not being collected, but HMRC can legitimately point out that they are bringing in a record share of the expected tax take. That both these things can be true simultaneously tells us more about current tax levels than anything else.

“There are some alarming revisions in these numbers, especially with respect to small business non-compliance. Rising numbers of business insolvencies (and general inability to pay) are also having an impact on tax collection.

“These figures show there is plenty of work for HMRC to do in a range of areas to reduce the tax gap. However, we should not lose sight of the fact that their record, collecting more than 95 per cent of tax due, compares well internationally.”

CIOT has also commented on some of the individual components of the tax gap.

Taxpayer mistakes / Making Tax Digital

The report puts tax lost due to taxpayers’ failure to take reasonable care in 2022-23 at £12.0 billion (1.5% of total theoretical liability) and tax lost due to taxpayer error at £5.8 billion (0.7%). The figures for 2021-22 were £11.8 billion (1.6%) and £6.0 billion (0.7%) respectively.

John Barnett commented: “These findings demonstrate the impact of our overly complex tax system. Nearly £18 billion – almost half- of the tax gap relates to taxpayers not getting things right through what HMRC categorise as either error or a failure to take reasonable care.

“Ironically, it is these aspects of the tax gap figures which have seen the greatest corrections by HMRC, with their original estimates for 2021-22 being £10.7 billion (1.4%) for failure to take reasonable care and £5.4 billion (0.7%) for error. So, HMRC previously underestimated both these elements by more than 10 per cent.

“We are now several years into Making Tax Digital (MTD). With mistakes costing the Exchequer nearly twice as much in cash terms as before MTD was introduced,² it is hard to discern whether MTD is meeting its objective of reducing avoidable errors, though we note that the ‘VAT gap’ has continued a long-term trend downwards. The theory behind digitalisation of the tax system is sound, but if MTD is not delivering the anticipated revenues, its future needs reassessing.

“We remain concerned that HMRC’s own customer service may be having an impact, too. The difficulties being faced by taxpayers and their agents in getting clarity and timely service from HMRC could be leading to increased losses of tax from those who want to be compliant, but are unable to get the support they need. It emphasises the importance of improving service levels on helplines and dealing with correspondence, as well as providing and publicising accessible, clear guidance.

“In any case it is vital that HMRC investigate what is causing increasing levels in carelessness and error figures and what they can do to help taxpayers take reasonable care with their tax affairs and get them right.

“The new government must also focus on the need for simplification. A simple tax system, with clear rules and easy to navigate guidance will lead to fewer mistakes by both taxpayers and tax authorities.”

Small businesses

Small businesses³ comprise the largest component of the overall tax gap by customer group at a 60% share in 2022-23 (£24.1 billion), up from 56% in 2021-22 (£22.6 billion) and 44% in 2019-20 (£17.8 billion).

Within this the corporation tax element of the small business tax gap now stands at £10.9 billion, a massive 32.2% of total theoretical liabilities. This contributes to corporation tax overall increasing from 17% of the total tax gap in 2018-19 to 34% in 2022-23. Worryingly, HMRC’s compliance activities now only bring in around a tenth of corporation tax revenues that would otherwise be lost, as compared to around half ten years ago.⁴

John Barnett commented: “While large businesses and wealthy individuals are often accused of not paying enough tax these figures suggest that their total share of the tax gap is only a quarter of that of small businesses.

“The small business figures reflect big upward revisions from HMRC as a result of a random enquiry programme carried out in 2020-21, which identified greater inaccuracy and non-compliance than previously forecast.

“While HMRC have not broken down these figures by different types of behaviour within the small business population, given that failure to take reasonable care and error make up nearly half of the overall tax gap, it is reasonable to surmise that a lot of this is due to small business owners making mistakes with their tax.⁵

“It would be helpful to have more data from HMRC to explain whether this is the case and what kind of mistakes small businesses are making, and why.  It seems that there is work to be done on educating and helping small business owners to understand their tax obligations better.”

Non-payment

The report puts tax lost due to ‘non-payment’ (largely taxes written off as a result of insolvency) in 2022-23 at £5.2 billion (0.6% of total theoretical liability). This is significantly up on 2021-22 (£3.3 billion; 0.4%), though consistent as a share of the theoretical liability with earlier years back to 2015-16.

John Barnett commented: “This rise in non-payment reflects a sharp increase in company insolvencies. These rose from about 11,000 in 2020-21 to 17,000 in 2021-22 and to nearly 23,000 in 2022-23.⁶

“Non-payment usually mostly reflects the state of the economy, rather than anything HMRC and other parts of government can control. Economic support measures such as furlough, temporary tax cuts and taxpayers being given more time to pay helped many businesses survive the pandemic, but rising levels of insolvencies in the years since are now hitting HMRC in the pocket.

“With insolvencies continuing to rise in 2023-24, this portion of the tax gap is likely to continue to rise when the next set of tax gap figures come out in a year’s time.”

Criminal activity

The report puts tax lost due to evasion in 2022-23 at £5.5 billion (0.7% of total theoretical liability), tax lost due to criminal attacks on the tax system at £3.5 billion (0.4%) and tax lost due to the hidden economy at £2.2 billion (0.3%). The figures were £5.4 billion (0.7%), £3.7 billion (0.5%) and £2.3 billion (0.3%) respectively in 2021-22.

John Barnett commented: “The picture on illegal activity is once again mixed. The amount lost to criminal attacks continues to fall, down by more than a billion since 2019-20, and HMRC and other law enforcement bodies deserve credit for this. But the share of taxes lost to the hidden economy and evasion is broadly unchanged.

“This suggests that while the Government’s efforts in the first half of the 2010s to put extra resources into identifying and tackling tax evasion and other illegal activity were successful, they 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.”

Avoidance

The report puts tax lost due to avoidance in 2022-23 at £1.8 billion (0.2% of total theoretical liability). The 2021-22 figures were £1.5 billion and 0.2% respectively. The first tax gap figures (2005-6) put the ‘avoidance gap’ at £4.8 billion (1.1%).

John Barnett commented: “Tackling avoidance remains the big success story of efforts to tackle the tax gap. Back in 2005 we lost £11 in every £1,000 to avoidance. Now it is just £2.

“The profile of tax avoidance in political and public debate belies the fact that it remains a relatively small part of the tax gap.”

Legal interpretation

The report puts tax lost to ‘legal interpretation’ in 2022-23 at £3.9 billion (0.5% of total theoretical liability), identical to the 2021-22 figures.

John Barnett commented: “On top of the nearly £18bn lost to taxpayer mistakes, a further £3.9bn is (in theory) lost to “legal interpretation”.  These are cases where HMRC and the taxpayer dispute the correct legal position.  As HMRC are not always right, the actual figure will be lower than this.  But a simpler tax system would also have less room for such disputes to arise.”

Notes for editors

1. Measuring tax gaps 2024 edition: tax gap estimates for 2022 to 2023 
2. In 2018-19 failure to take reasonable care was £5.9 billion and error was £3.1billion, a total of £9.0 billion. 
3. Small businesses include both unincorporated businesses and small limited companies. 
4. See table 5.1 of Tax Gaps 2024 online tables 
5. Table 4.5 indicates that 39% of SA tax returns filed by business taxpayers had under-declared their tax liability, of which 16% had under-declared it by between £1 and £500, 6% by between £501 and £ 1,000 and 16% by over £1,000. Table 5.3 indicates that 45% of CT returns filed by small businesses were incorrect. 13% had an additional liability of between £0 and £1,000, and 32% an additional liability of greater than £1,000. 
6. Source: https://www.gov.uk/government/statistics/monthly-insolvency-statistics-february-2024