Partner Article

Big hole in HMRC’s tax gap figures?

The Institute of Economic Affairs has published a challenging report on The Shadow Economy. This estimates that in the UK the shadow economy constitutes approximately 10% of GDP.

With UK GDP now running at an estimated £1.45tn per annum, it looks as though the informal economy totals around £145bn a year.

What is the shadow economy? Definitions vary so the IEA has, quite sensibly, used a relatively narrow definition. It regards the shadow economy as all market-based production of legal goods and services that are deliberately concealed from public authorities to avoid:

• payment of tax or social security contributions;
• meeting legal labour market standards such as minimum wages, maximum working hours and safety standards;
• administrative obligations.

Illegal activities are therefore excluded from the report (even if they would be taxable).

On that basis, the £145bn estimate for the value of the shadow economy looks like a sensible minimum.

It’s reasonable to ask how much tax is lost through the shadow economy. This is an extremely difficult question, and one which the report’s authors – wisely, many would say – do not attempt to answer. However, it’s possible to make an informed estimate of the tax cost of the shadow economy by looking at estimated government receipts for 2013/14.

In its Budget Day 2013 red book, the Treasury estimates that government receipts derived from all forms of taxation (including council tax and business rates) are around £600bn. If that’s only 90% of what it should be, because the shadow economy accounts for 10% of the total, then it looks as though the shadow economy costs the Exchequer around £66bn in lost taxes each year. Now for the big disclaimer: that’s a massive simplification because, as the report’s authors recognise, bringing the shadow economy into the formal economy has a complex effect on not only the direct taxes but also VAT and, most especially, social security benefits. But, in the absence of better data, an estimated tax loss in excess of £60bn a year tells us that, even if the size of the shadow economy in the UK is significantly below the average for the largest 21 OECD countries, it’s still a problem which has to be taken very seriously.

So, how does all this compare with the official UK tax gap figures? The latest HMRC estimates of the UK tax gap are for the year 2010/11. They say that the hidden economy and tax evasion together produce a tax gap of £9bn. This is only around one seventh of the figure implied by the IEA report.

Perhaps it’s time for HMRC to look again at its own tax gap figures, and for the Treasury to consider what resources should be made available to HMRC to tackle tax loss through the shadow economy.

This was posted in Bdaily's Members' News section by George Bull .