You might be forgiven for thinking that it was a good news story.
Today HMRC released its ‘tax gap’ figures — its detailed estimates of the amount of due taxes that have gone unpaid thanks to error, carelessness, avoidance, evasion and fraud. The tax gap is a key metric for HMRC’s performance in collecting the nation’s taxes. And as discussed below, the government’s spending plans are unusually dependent on making the tax gap figure go down.
Today’s sunny press release from HMRC seems to offer hope:
The tax gap estimate – the difference between what UK tax is expected to be paid and was actually paid – was 6.4% for the 2024 to 2025 tax year….The percentage tax gap has fallen from 7.5% since measurement began in 2005 to 2006, although there has been some fluctuation over that period.
The real story, though, is in those last nine words (emphasis added). HMRC’s Tax Gap statistics provide a figure for the amount of unpaid tax in the previous year (2024-25) – but every year’s statistical release also revises the figures for previous years. There’s nothing illegitimate about this. HMRC may find that there was more tax due in previous years than it previously thought (for instance, due to higher trade figures making VAT liabilities go up). Or it might identify more missing tax as big compliance cases develop, covering multiple previous years.
These historical revisions are particularly large this year. Not only is HMRC’s estimate for the 2024-25 tax gap bigger than for 2023-24, but in fact the tax gap seems to have been going up overall in the previous six years (the pink line).
This is very different to the picture that HMRC published last year (the blue line). Last year’s figures showed the Tax Gap increasing a bit around 2019-20, but then generally declining.
As the graph below shows, this year’s revised story is much more pessimistic.
Not only is the 2024-25 tax gap estimate £6.4 billion larger than in the previous year (2023-24), but HMRC now believes that that 2023-24 tax gap was also £6 billion bigger than previously thought: 6 percent of the nation’s tax liabilities, rather than its previous estimate of 5.3 percent.
HMRC’s figures suggest that the overall tax gap in 2024-25 was a record £59.2 billion. That’s roughly equal to the UK’s defence budget in that year.
What does this mean for the public finances?
The untold story of this government’s economic plans is that they’ve bet the house on closing the tax gap.
All governments tend to try to balance the books by promising to tackle tax avoidance and evasion. But the current government’s spending plans are unusually dependent on shrinking the tax gap. Rachel Reeves has promised that by the end of this parliament HMRC will be collecting nearly £9 billion extra revenue every year thanks to measures to improve tax compliance and lower the tax gap. This package of ‘tax gap’ measures – extra staff, data and technology – is the government’s third biggest revenue-raising policy, though it receives much less attention than headline-grabbing policies like the ‘farm tax’.
Yet today’s figures suggest that the tax gap is not only larger than previously thought, but also going in the wrong direction: rising overall since 2017-18 as a proportion of the nation’s tax liabilities, and increasing by over £6 billion in this government’s first year in office.
Obviously no government will ever make the tax gap go to zero, or even close to it. But today’s figures show that they have considerably further to go then previously thought.
That’s a reality that any new incoming prime minister or Chancellor will have to grapple with. If they want to stick to existing spending commitments, let alone make new ones, then part of making the books balance will have to be going much further and faster with tackling the tax gap.
It’s important to note that HMRC (usefully) describes figures for 2023-24 and 2024-25 as “provisional”. They will certainly change in future years. But as the graph above shows, previous years’ figures are almost always revised upwards, not downwards. So future tax gap statistics are very unlikely to make the problem go away.
Why is the tax gap getting bigger?
Before we dig into the detail beneath the headline figures, a technical (but important) complaint. In previous years HMRC has published the component elements of the tax gap for each different tax, behaviour or taxpayer category in two ways: as an absolute figure (in billions of pounds), and as a percentage of tax theoretically due.
For obvious reasons, it’s the percentage figures that really matter as a measure of non-compliance. If we only looked at the tax gap’s absolute value in pounds, then overall amounts may go up year-on-year simply because overall tax liabilities have increased – for instance due to inflation or increased tax rates. That doesn’t mean that levels of non-compliance have increased.
This year, however, HMRC has got rid of the “percentage of theoretical liabilities” figures for different taxpayer groups, and different types of non-compliance. Instead they present the tax gap for each of these categories simply as a percentage of the overall tax gap. That makes it difficult to tell whether non-compliance is going up or down for particular taxpayer groups or behaviours. The change also makes it hard to compare with previous years’ tax gap statistics. That’s an obstacle to anyone wanting to figure out what’s going right or wrong with UK tax administration.
Nonetheless from the breakdown of the tax gap by different taxes, we can see that there are some culprits. A lot of things are going up a bit, but the four big drivers since 2018-19 are:
- small business corporation tax, up from 24 percent to 45 percent of tax liabilities, an increase of £12.7 billion, and now accounting for nearly a third of the whole tax gap;
- individual business self-assessment – mostly income tax, national insurance and capital gains tax – up from 24 to 29 percent of liabilities, an increase of £4.8 billion;
- (to a lesser extent) large business corporation tax, up from 3.3 to 4.3 percent of liabilities, an increase of £1.3 billion;
- (to a lesser extent) VAT, which has actually fallen over this period from 8.3 to 6.6 percent of liabilities, but risen in absolute terms by £2.1 billion.
There are different stories behind each of these, which we’ll be exploring this week and coming weeks in a series of posts. First up, tomorrow: the small business tax gap.
(Spoiler – it’s not just about vape shops).
Photo by Hadyn Cutler on Unsplash
