HMRC have published ‘Measuring Tax Gaps 2010’ – the statistics relating to estimates of tax gaps – defined as being the difference between tax collected and that, which in HMRC's view, should be collected.

This official statistical release presents the latest estimates of tax gaps for 2008/09 in HMRC administered taxes. The report was first published in December 2009 for the tax year 2007/08.

The report estimates the scale of, and trends in tax gaps and points out that this is a difficult and a relatively untested area of work for governments in the EU and around the world. HMRC has developed estimates for tax gaps for the main direct and indirect taxes which it administers and that it believes are the best possible, based on all the information presently available. However HMRC are keen to stress that all of the tax gap estimates therein are subject to error.

And now to the interesting part.

The tax gap is initially defined as “the difference between tax collected and the tax that should be collected (the theoretical liability)”. Overall the total tax gap is estimated to be £42bn in 2008/09. This equates to around 9 per cent of the total tax liability. Historically the tax gap appears to have increased some 10.5% from the 2007–2008 published figure of £38bn.

There are many potential reasons for this increase over what has effectively been a period of significant economic decline and recession in the UK economy and in the context of further spending cuts by the Government.

Many will view the ‘tax gap’ as an indication of the size of the UK's black economy. However it is important to point out that it is much more than that. The figures comprises inaccurate returns, avoidance schemes and activities, technical disparities between taxpayers and HMRC as well as the tax gap arising from ‘ghosts’ (defined as individuals who have earnings from employment/self-employment and fail to declare any of this income) and ‘moonlighters’ (defined as individuals who pay tax on their main job through PAYE but have a second job or additional income from self-employment).

This year's calculation of the ‘tax gap’ has also been revised since the previous publication to include ‘non-payment’ for direct taxes within the various relevant component estimates of tax gaps. This is to provide consistency with the indirect tax gap estimates which cover all sources of revenue loss including non-payment.

So, as one would expect ‘non-payment’ of tax to increase over the period of economic decline as cash flows become constrained, it would be natural to also expect an increase in the tax gap as a result. But - it is important to note that ‘non-payment’ is defined as losses from amounts written off in HMRC's financial statements, i.e. debts that are not collectable. Direct tax debts that are later paid off do not form part of the direct tax gap, although payment will be deferred. However due to timing effects the amounts written off during the year will not necessarily relate to liabilities arising during the year.

HMRC first published an estimate of the tax gap in 2009 as an experimental set of statistics. Due to the experimental nature of the study at that time, the estimates for the overall tax gap and the total tax gaps for indirect and direct taxes were rounded to the nearest £5 billion. This time around some of the methodologies have become more established and some have been improved.

Therefore the estimate for the overall tax gap has been rounded to the nearest £1 billion and the estimates for the total indirect and direct tax gaps have been rounded to the nearest £100 million.

£22.5bn of the 2008–2009 gap appears to come from direct taxes with £14.5bn coming from the category comprising Income Tax, NIC and CGT. Corporation Tax makes up approx. £6.9bn of the gap.

Aside from tobacco duty and the Northern Ireland Diesel Duty figures, the largest % disparity arises in VAT (16%) and Corporation Tax (13.9%).

Perhaps what is most interesting about the report is what it does not say. The remit of the report was not to try and explain the reasons for the size of the gap or for the apparent 10.5% increase from last year. That in itself would have been a difficult exercise. Thus it has been left to interested parties to draw their own conclusions. And at a time when the PAYE reconciliations issue is still fresh in the mind of many taxpayers and with the 20 October spending review also imminent - it's not difficult to see that HMRC may be in for a rough ride for some time to come.

HMRC welcomes feedback on this paper from businesses, academic experts, and other interested parties, with a view to discussing and, where possible, improving the methodologies employed further. The full text of the report can be accessed http://www.hmrc.gov.uk/stats/measuring-tax-gaps-2010.htm.pdf