At each election when political parties produce their tax and spending plans, they come up with a figure for how much they will raise from reducing tax avoidance and the collection of unpaid tax. This often feels like a convenient amount that allows them to claim that their spending plans are fully costed and funded.
In their manifestos for this election, the Conservatives say they will raise a further £6bn a year from tackling tax avoidance and evasion by the end of the Parliament.
Labour says they will raise £5.1bn a year by the end of the Parliament through the modernisation of HMRC and investing in new technology.
The Lib Dems claim that they can raise over £7bn a year by tackling tax avoidance and evasion. Reform agrees.
None of them, however, explain in any detail how they have arrived at these amounts or how their claims will be achieved. It begs an obvious question. If this is possible, why is it not being done already?
HMRC produces a report every year on what it refers to as the “tax gap”. This is the difference between how much tax is collected each year, and how much tax it thinks should be.
For 2021-22, the tax gap was estimated to be 4.8pc of total theoretical tax liabilities, being £35.8bn in absolute terms. Put another way – HMRC only collected 95.2pc of all tax theoretically due.
The head of the National Audit Office (NAO) told Parliament in January that £6bn a year could be recovered through a concerted effort on tax avoidance.
What is the tax gap?
Cynics might assume that the tax gap is little more than an educated guess. However, the Chartered Institute of Taxation (CIOT) has produced a helpful guide on exactly this issue, and you may find the results surprising.
For example, the largest part of the gap at over £20bn is not from multinationals but from small businesses with fewer than 20 employees. Big companies represented less than £4bn of the gap, and wealthy individuals just £1.7bn. Only £1.4bn is related to tax avoidance.
Interestingly, the gap has been closing. The amount that HMRC thinks it would bring in if everyone was perfectly compliant has fallen by about a third – from 7.5pc of the total liability in 2005-06 to 4.8pc in 2021-22.
A number of important measures have been introduced over the years to help achieve this.
In 2004, Gordon Brown brought in the “disclosure of tax avoidance schemes” regime. George Osborne introduced the General Anti-Abuse Rule (GAAR) in 2013, and then in 2014 brought in measures to encourage adherence to court decisions.
Public attitudes to tax avoidance have also changed, partly as a result of media pressure.
This has resulted in the large fall in tax avoidance. In 2005-06, it was estimated that £11 in every £1,000 of tax was avoided, but that has now been cut to just £2 in every £1,000.
The numbers also show a success in tackling illegal activity, with that part of the tax gap halving between 2005-06 and 2021-22. It is now estimated to be £15 in every £1,000, split £6 to criminal attacks, £6 to evasion and £3 to the hidden economy.
How could the tax gap be improved?
I think there are two main ways in which the position could be further improved. With a few exceptions, taxpayers want to pay what they owe and sleep easy at night having done so.
Firstly, tax is far too complicated, particularly for the vast majority of taxpayers who cannot afford professional advisers, and errors arise from this. All chancellors regularly say that they want to simplify taxes but seldom do so. A new chancellor could be the one that does.
Secondly, we urgently need better guidance from HMRC and the ability to access help from the department when needed. As we have regularly reported, HMRC service levels have been falling and that must be reversed.
In summary, further improvements could be made and the targets being proposed might be achieved, but tackling the gap from here on will require additional resources and that carries a cost.
It also requires the political will to do so. For example, the NAO says £5.5bn a year continues to be lost through fraud and error on Universal Credit.
Remember also that the Government gave up chasing £4.9bn of Covid loans, prompting Rachel Reeves to claim it was “a source of enduring shame to the chancellor”.
In addition, a law of diminishing returns applies. Many small businesses simply do not have the money to pay the tax due and putting them into receivership is no solution.
Multinationals are not necessarily to blame
Finally, it is often claimed that revenue is lost through large multinational companies finding clever ways of getting round the rules. Much of this flows from heavy criticism a few years from the Public Accounts Committee, directed at Amazon in particular.
In my view, this criticism arose from a misunderstanding by the committee of the way the tax rules work, particularly for UK subsidiaries of offshore quoted companies. I will take Amazon as an example, but there are many others.
Most commentators look no further than the corporation tax charge disclosed in the company accounts. In 2018, the Amazon UK Services Ltd accounts disclosed a tax charge of £1m on profits of £75m. However, note eight in the accounts shows that this amount was calculated after taking relief of £23m for share-based awards.
Amazon has a generous share scheme for UK employees with shares awarded in and by the US parent company. This, and a rapidly rising share price, meant that the UK employees realised large profits when they exercised their share options, typically three years after they were awarded.
These profits were subject to income tax and National Insurance in the UK through the PAYE system, despite the award being in shares in the US parent company.
Under an entirely logical rule introduced by Gordon Brown, companies are entitled to claim a corporation tax deduction on the amount of this profit. So, although the reduction on corporation tax was £23m, the UK Treasury collected about three times that amount in PAYE/NICs over and above the tax on their employees’ wages.
Now that the Amazon share price has stabilised the equivalent amounts in the 2022 accounts show that the share-based relief has virtually disappeared, leaving a corporation tax charge of £66m on profits of £222m, an effective rate of 30pc. Strangely, the Public Accounts Committee has been silent on this.
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