4.24 The Tax Gap

Primary Reference to Article 15 - Tax Administration Generally

The tax gap is the gap between tax revenues with 100% compliance and what is actually raised. The amount can only be estimated because the extent of non-compliance is not known precisely. Many estimated are given by governments with unsatisfactory back-up. Tax professionals often believe the government estimates are overstated, but no one really knows for sure.

The non-compliance can arise from various sources; stealing VAT, cash transactions which are not recorded, barter transactions, offshore tax evasion, false expenses, illegal activity etc. It is particularly common in taxing "the hard to tax" being small independent businesses, agriculture, fishing, and the poor.

It is never possible to eliminate the tax gap because there will always be a proportion of people in a taxpaying nation who will not comply regardless of enforcement, penalties, prosecution, or concepts of fairness. So the idea is to reduce the tax gap as much as possible. Because the tax lost via the tax gap must be paid by others, it is particularly important to rigourously and constantly monitor and challenge those who participate in such activities.

Systems can prevent certain aspects of tax cheating by denying the opportunity (say through withholding of tax at source). Certain countries have resorted to asking customers on the street to show a VAT invoice for goods they purchased and have in their possession. However the practicalities of such an approach in a country like China with 1.4 billion people, or developing countries in Africa where people have never been taxed, are questionable.

Even a tax gap of 10% is too much but hard to avoid if the widely quoted statistics are accurate.

Adopting a Taxpayer Charter will not eliminate the tax gap but it may help to reduce it. People obey laws for many reasons, among them being:

  • fear of being caught and penalized or prosecuted
  • simply because it is the law
  • because they agree with the law (it makes sense and is fair)
  • because of peer pressure, everyone else obeys the law

The Taxpayer Charter carries special weight in the last two categories, broadly being that people are more likely to comply with something that they (and their compatriots) judge as fair than something they believe is unfair.