How do you solve a problem like tax avoidance: where is the problem

In yesterday’s blog post, I looked at the tax gap and what, conceptually, the headline figure of £32bn represented. I noted that it might, in fact, considerably underestimate the tax that you and I might think is due on activities in the United Kingdom.

Today I want to make a short point about where the tax gap arises? Because it’s only once you know where it is that you can begin to formulate practical policy to close it.

The areas where the tax gap arises are set out at page 4 of this document. I don’t mean to go through them all (they’re summarised in the chart below) but there is one surprising fact which jumps out at you.

By far the single biggest constituent element in the tax gap is VAT, which accounts for £9.6bn of the £32bn. So VAT makes up 30% of the tax gap but only 19% of tax receipts. The VAT tax gap is both huge in absolute terms – and far higher as a percentage of the tax that should be collected than for other types of tax.

Even if one one strips out VAT that’s declared but not paid (about £0.9 bn) and VAT lost to a particular infamous type of VAT fraud (so-called Missing Trader Intra Community Fraud) (£0.5-£1bn) one is still left with £8bn of VAT that’s not even declared. That’s about double the corporation tax tax gap (which is £4.1bn, split fairly evenly between SMEs, Large and Complex Businesses; and Businesses Managed by the Large Business Service (don’t ask)).

This comparison tells us a number of things. First, and most obviously, we ought to be talking more about VAT and less about corporation tax. Second, given that the overwhelming part of the VAT liability falls upon households (over 80% if one strips out exempt transactions) we should be exploring ways in which households might help HMRC collect VAT, for example by requiring households to ask traders with whom they deal for invoices. And, third, once we ‘sense-check’ our understanding of where the gap is against the data about the behaviour to which the gap can be attributable we begin to be able to formulate further ideas about the measures necessary to close the gap. I’ll examine the behaviour question tomorrow.

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