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  • By AJ
  • 3rd July 2019

The tax gap – and the next PM wants to cut taxes further…

The tax gap – and the next PM wants to cut taxes further…

The tax gap – and the next PM wants to cut taxes further… 150 150 AJ

HMRC has recently published the 2019 edition of Measuring tax gaps which shows estimates of tax lost in 2017/18. Worryingly, the “gap” for 2018/18 is estimated at £35 bn, or 5.6% of total tax due. The 2017/17 figure was £33 bn (5.7%), so little progress has been made in reducing this.

How does this fit, then, with our next PM’s wish to cut taxes? A 14th-Century Islamic scholar, Ibn Khaldun, was the original tax-cutter. He argued that lower taxes stimulate activity, which creates wealth and that generates more tax receipts. This is the concept behind the Laffer curve. Some 500 years after Khaldum’s first postulation, Art Laffer, the American economist, picked up the theme during the Nixon administration. He explained that there is an optimal rate of tax somewhere between zero (where no tax would be collected) and 100% (which would deter anyone from work and hence raise nothing either). The simplicity of this logic stuck and became the theoretical foundation for reforms by both Ronald Reagan and Margaret Thatcher.

The Laffer curve is clearly enjoying a revival today. When President Trump slashed taxes in the US, the Treasury secretary claimed “the tax plan will pay for itself in economic growth”. Now, it appears, our next UK PM wants to do the same thing.

There’s a big problem though. In order to be effective, you need to know where the Laffer curve peaks – and no one does! It moves around according to the sophistication of tax lawyers and accountants, social mores, and perhaps, most importantly, the effectiveness of the tax system in collecting the taxes due.

So, we’ve completed a virtuous circle!

If we look at the 2018/18 tax gap, the largest share is due to income tax, NICs and CGT at £12.9 bn. This includes £7.4 bn in respect of self-assessment of which £4bn is attributable to the self-employed. The VAT gap is £12.5 bn whilst corporation tax accounts for £5.2 bn.

Demographically, the largest culprit is small businesses, followed by large businesses, mid-sized businesses and finally, individuals.

Behaviour-wise, criminal activity amounts to £4.9 bn, the hidden economy and tax evasion accounts for £3 bn and £5.3 bn respectively. Avoidance accounts for £1.8 bn.  Errors and mistakes amount to a staggering £9.8 bn.

So, what are my conclusions about both the tax gap and tax rates in general?

  • Tax evasion and illegal activities account for seven times as much as tax avoidance. The focus should, therefore, be on reducing the former and not making the tax system even more complex by addressing the latter which also has the knock-on effect of penalising many innocent and commercially-driven decisions.
  • Make the tax system simpler. If so much is lost due to mistakes, making the system even more complex is simply daft.
  • Address practice, not theory. The Laffer principle is a great hypothesis, but impossible to get right.
  • And finally, on a personal note, let’s stop being greedy and pay our taxes (the correct amount – not more or less) with good grace, thankfulness, and optimism (hopefully not mis-founded) that they will be used wisely.

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