The government’s promise to close the tax gap

What’s the tax gap?

“The tax gap” refers to the difference between the total amount of taxes owed to the government and the amount actually collected. In 2024, , or 4.8% of overall theoretical liabilities. :

• “It provides a useful tool for understanding the relative size and nature of non-compliance.”
• “It provides a foundation for HMRC’s strategy – thinking about the tax gap helps us understand how non-compliance occurs and how we can address the causes and improve the overall health of the tax administration system.”
• “Our tax gap analysis provides insight into which strategies are most effective at reducing the tax gap.”

But what exactly is being measured here? Is it useful, and if so, is it useful in the way it is currently used?

Do we want HMRC to close tax gap completely?

The implication of “closing the tax gap” is that ideally, we would have a £0 tax gap, although HMRC does acknowledge that “It is impossible to collect every penny of tax that is owed”. It is worth asking, is this an appropriate ambition? As taxpayers, do we want HMRC to pursue every last £1?

HMRC claims their cost of collection has stayed the same since 2018 at about 0.5%, although we notice this methodology has been recently changed with costs removed from the calculation. (For the year 2022/23, HMRC cost over revenue generated gives a figure of 0.8%.) Presumably, the absolute costs will continue to increase, given the 5,000 new HMRC staff that have been announced.

Some tax is always going to be more expensive to collect, to the point that pursuing some tax matters may even be lossmaking from HMRC’s perspective (every time they lose a tribunal decision, for instance). Therefore, some level of tax gap may be appropriate, and even desirable, to reflect this.

Closing the tax gap in the 2024 Autumn Budget

The government’s 2024 Autumn Budget had an entire section on “Closing the tax gap”, in which they set out ambitions to raise £6.5bn in additional tax revenue per year by 2029-30.

It’s a familiar trope, and tax professionals are accustomed to the public perception of what this means. The story goes that there are very large international businesses, and maybe some hidden economy businesses, “dodging their fair share of tax”, and this government intends to make them pay. So far, so vote-winning (perhaps). But do the numbers in the budget reflect this story?

Looking at material items in the breakdown of the £6.5bn given in the budget documents, £4.8bn of this is just the increased collection of tax due and tax debt due to the new HMRC officers. This is interesting in itself, but doesn’t really explain where the revenue is expected to come from.

A further £700m is from modernising HMRC systems. There’s no description regarding how this is expected to “close the tax gap”, but it would be reasonable to think that HMRC is more likely to detect anomalies which may reveal some hidden economy taxes if it has better systems. While this is likely welcomed by many tax professionals (including anyone who has ever sent a fax to HMRC), it’s not clear why this is £700m rather than £70m or indeed £7bn.

£215m is anticipated from raising the interest rate on unpaid tax to 4% plus the base rate. This approach aims to make tax collection more punitive, but it blurs the line between interest and penalty regimes. Historically, interest has not been intended as a punitive measure, and this change could discourage voluntary disclosures, potentially reducing overall tax compliance and decreasing revenue.

Is the current tax gap calculation meaningful?

Although a lot is published by HMRC about the tax gap, it is quite difficult to find a meaningful calculation of how it is produced. Digging into the methodological annexe reveals that, in general, direct tax gaps are calculated by reference to “bottom up” methods, while indirect tax gaps are collected using .

As a specialist in corporate tax for large businesses, I was interested in the “bottom up” method used for direct taxes, and found these are statistical methods that extrapolate from risk-based compliance checks.

What this means is that HMRC will conduct risk-based compliance checks (enquiries where it has reason to believe there may be an issue, as opposed to randomly), take the amount of tax found as part of these compliance checks, and then use this to estimate what else might be out there that hasn’t been found.

At first, this sounds sensible. But consider: what would have to happen for this calculation to hit zero? If the tax gap is a proportion of the tax found, then the only meaningful way for the tax gap to close is, ridiculously, for HMRC to stop finding tax.

Moreover, with the planned addition of 5,000 new HMRC staff, more compliance checks are expected with more tax found, potentially leading to a higher reported tax gap.

This makes the tax gap as a measure of HMRC performance counter-intuitive. In the case of “Large Business” corporate tax, if HMRC conducts the most efficient risk-based compliance checks where it will find the most tax, it will see the tax gap go up. (Note that the methodology for medium-sized businesses is the same, but for small businesses it is extrapolated from random enquiry methods, rather than risk-based, so this does not apply to the same extent.)

Rethinking the tax gap

The concept of the tax gap may be useful, and HMRC’s policy work is not necessarily incorrectly directed. For instance, discussion of the hidden economy and the focus on tax governance are both initiatives that are likely to lead to more tax being paid.

However, if the calculation of the tax gap uses data about what HMRC has found in order to estimate what might be there to be found, it is difficult to see how it is a useful measure of performance. It certainly does not necessarily follow that an increased tax gap, as calculated, is an increase in businesses “dodging their fair share of tax”.

The government is proposing to increase the HMRC workforce by about 8%, expecting this to significantly boost revenue collection. It’s important to evaluate if the appropriate performance metrics are in place to ensure this goal is achieved.

Overall, it may be more useful to think of the tax gap as a concept rather than a number to be easily measured, as almost by definition, the more exact the measure, the easier it is to collect the tax, such that it is no longer a gap.