Estimates and guesstimates – mind the tax gap

April 24, 2013

In an ideal world, tax authorities would seek to narrow the gap by targeting both evasion and avoidance. But isn’t the tax gap a guesstimate?

How big is the tax gap?

The truth is no one really knows – if every taxpayer, corporate and individual made an honest declaration of their finances, or the tax authorities had perfect information, assessing the difference between total tax due and total tax paid would be simple. But then there probably wouldn’t be a tax gap to speak of.

Still, Benjamin Franklin’s oftenquoted warning that nothing in life is certain but death and taxes could do with updating. It’s just as certain, wherever in the world you look, that not everyone pays all the tax they should.

In the UK, the latest estimate of the tax gap is that HM Revenue & Customs (HMRC) collected £32b less tax last year than it was owed. In the US, the IRS’s most recent figure is $350b.

Two elements are clear in the tax gap

Across the Eurozone as a whole, the current estimate is that the tax gap could be as high as €1t. In each case, the gap comprises two distinct elements:

  1. There is tax lost to evasion – clearly illegal behavior
  2. And there is tax lost to avoidance – tax planning strategies that stay on the right side of the law with each step of a transaction, but overall nevertheless deprive authorities of revenues they had been expecting to collect

In an ideal world, the tax authorities would seek to narrow the gap by targeting both evasion and avoidance. But the crackdown on corporate tax avoidance that is so marked around the world suggests the focus has been more targeted.

This is an odd strategy given the breakdown of the tax gap figures.

  1. Far more tax revenue is lost to evasion than avoidance – that €1t Eurozone tax gap, for example, may well be 85% evasion.
  2. Corporate tax avoidance is only a tiny part of the total. In the UK, for instance, HMRC puts the amount lost to tax avoidance strategies at large companies at less than 3% of the total tax gap. In almost all economies, indirect taxes and direct taxes on individuals account for far greater sums.

The figures suggest, in other words, that multinational companies may not offer the richest pickings for authorities in closing the tax gap, even if they are the easiest political target.

Not that the figures should be taken entirely at face value. Even the statisticians who compile tax gap data concede that they are, at best, well-informed “guesstimates”.

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