Mind the gap: Countries should take action on uncollected revenues
By Justin Whitehouse - April 25, 2012
We’ve all seen the headlines: Canadian government reports unprecedented deficit; U.S. elected officials clash over debt ceiling; Greece teeters on the edge of default. They all point to the monumental fiscal struggle most countries are engaging in these days. But, what if there was a way to put billions of dollars back into government coffers—money that is technically their due? That’s exactly what could happen if countries step up their efforts to address the tax gap.
Simply put, the tax gap is the difference between the tax collected and the theoretical tax liability if every taxpayer complied with the letter and spirit of the law. Take the United Kingdom. It’s been estimated that in 2010 the tax gap was US$56 billion. In Sweden in 2010 it was estimated at US$20 billion. And in the United States in 2006, it was estimated at US$385 billion. (Sources: HMRC (UK), Swedish Tax Agency, Internal Revenue Service (US))
Taking action on eliminating this gap would seem like a top priority in today’s economy. But, estimating the scale of tax gaps is a difficult and comparatively untested area of work for revenue authorities around the world. The OECD estimates that fewer than half of surveyed revenue bodies, including those with a formal mandate to do so, undertake research efforts to calculate tax gaps.
Even those methodologies that exist for calculating the tax gap are often imperfect and are constantly being revised. It’s also extremely difficult to tell how the gap is split between intentional evasion and unintentional errors.
Yet some countries are trying to tackle this challenge. The Swedish Tax Agency (STA) has committed to halving their tax gap by 2014. They measured the gap using a variety of data sources and methodologies. In particular, they used a combination of indirect—such as comparing income statements with consumption and savings—and direct measures—surveys and audits—to calculate how much of the tax gap is “black work,” that is, undeclared, which they discovered accounted for 50 percent of the tax gap. These methodologies also allow the STA to further parse the “black work” market and develop remedies.
Of course, it’s not feasible to eliminate the tax gap completely. It’s also important that compliant taxpayers are not negatively impacted by efforts to close the gap. But there are a number of steps revenue authorities can take to identify and reduce this gap in a cost-effective way. Governments may need to review their anti-avoidance and anti-fraud laws to find ways to enhance transparency or close loopholes. Analytics can support these efforts by using government data to identify trends or other contributing factors.
Governments should also look for ways to improve compliance as well as revenue generation through enhanced debt collection or amnesties. A more active measure is to simplify the tax code. The complexity of the tax code is so critical to compliance that the World Bank uses it as a key factor in determining a country’s “ease of doing business” ranking each year. Taking on any of these measures to close the tax gap, however, may also necessitate a stronger tax administration. This can involve anything from improved operations to modernizing technology.
Undeniably, reducing the tax gap is not a straight-forward task. It will take a concerted effort by revenue agencies to develop the mechanisms not only to calculate and identify the gaps but also implement measures to bring that revenue in. But governments owe it to their tax-paying constituents to figure it out—and take action.
Justin Whitehouse is the Global Public Sector Tax Leader for Deloitte Touche Tohmatsu Limited (DTTL). He has extensive experience with commercial and government clients and is regularly consulted by industry bodies and tax authorities, with a special focus on indirect taxes, tax collection improvement and implementation of new taxes.