The Labour party has formed its first UK government since 2010. Its manifesto (discussed here) and ‘Close the Tax Gap’ document published prior to the election stated an intention to decrease the UK’s ‘tax gap’. This is the difference between tax collected and the amount HMRC considers ought to have been paid, and was recently estimated at £39.8 billion for 2022/23 (or 4.8% of total theoretical liabilities). With public sector net debt at almost 100% GDP (see this House of Common Library Research Briefing) and tax revenue as a share of GDP near an all-time high (see this IFS paper), extracting more tax receipts without increasing tax rates looks like a popular measure. 

Labour intend to raise an additional £5 billion annually by 2029/30 through decreasing the tax gap. But accounting for inflation, this may arguably not decrease the amount in absolute terms, but merely prevent it from rising with inflation. However, Labour’s plans suggest greater ambitions. The Close the Tax Gap document proposed the following:

• Legislative changes: Suggestions include expanding the UK’s disclosure of tax avoidance schemes (DOTAS) rules. No details were provided, so this will be an area to watch. 
• Tackling downstream non-compliance: Using part of Labour’s proposed £555 million of additional annual funding, HMRC would focus on tackling non-compliance by the most complex and high-value taxpayers (such as large businesses). Labour also planned to ring-fence amounts for strategically important criminal cases to act as a deterrent, and to address offshore tax compliance (with details to be confirmed when the relevant tax gap data becomes available). 
• Supporting upstream compliance: Some of the additional funding would also be used to support taxpayers to avoid unintentional errors. There were also plans for technological improvements (with another £300 million per year to be added to HMRC capital budget). 

This post considers to whom and to which behaviours HMRC’s data attributes the tax gap, before exploring Labour’s plans to decrease it and their implications. 

Who is responsible for the UK’s tax gap?

HMRC’s tax gap data for 2022/23 attributes an increasing share of the tax gap to small businesses, being 60% (£24.1 billion) in 2022/23 (up from 44% in 2018/19). Large businesses, by contrast, are attributed 11% (£4.7 billion) and the wealthy 5% (£1.7 billion) (see figure 1.4 copied below).

Comparing these figures with the tax receipts from each taxpayer population (derived from HMRC’s Corporate Report for 2022/23) shows that the tax gap attributed to small businesses is equal to 12.4% of their contribution. For large businesses and the wealthy, the percentages are respectively 1.3% and 1.7%. So, it appears that large businesses are amongst the most compliant taxpayer populations relative to the tax revenues they contribute. 

How is the tax gap caused?

HMRC’s data also considers which behaviours caused the UK’s tax gap in 2022/23 (see in particular figure 7.1, copied below). The greatest contributions came from a failure to take reasonable care when reporting tax liabilities (30%), with error (mistakes in calculations despite taking reasonable care) contributing 15%. Together, these unintentional failures caused 45% of the UK’s tax gap in 2022/23. This contrasts with tax avoidance (4%) and evasion (14%). 

How do Labour plan to decrease the UK’s tax gap?

Labour’s manifesto referred to having a “renewed focus on tax avoidance by large businesses and the wealthy” which “will begin to close the tax gap and ensure everyone pays their fair share”. On HMRC’s data, this would mean targeting a comparatively compliant population and the behaviour with the smallest contribution to the tax gap. However, the party’s Close the Tax Gap document shows more nuance. Labour broadly proposes three sets of measures:

1. Legislative change

In addition to taking forward the “outcome of the current view on regulating the tax advice market” (which presumably refers to this consultation from March 2024, the outcome of which has not yet been published) and strengthening HMRC’s powers to enforce payment of tax in an investigation (could this indicate an intention to broaden the circumstances when an accelerated payment notice can be issued?), Labour's Close the Tax Gap document suggests that they may widen the scope of the DOTAS rules. In the same sentence, the document refers to an intention to “consider whether to require all tax schemes to be disclosed”; it is unclear what this could mean or look like. Given the punitive consequences of a scheme falling under DOTAS, any extension should, however, be carefully targeted and considered. 

Another measure that could reduce unintentional errors (and thus the tax gap) and also reduce compliance costs would be to simplify (or at least not further complicate) the UK’s tax system. It would certainly be welcome not to see a further proliferation of additional taxes following the raft of new taxes introduced since 2010 (see this IFS report). Labour’s Closing the Tax Gap document does not address this point although the manifesto promised that Labour would “stop the chaos" on business taxation. The King’s Speech already confirmed an overhaul of the apprenticeship levy and the removal of the VAT exemption for private school fees (both of which were part of the manifesto), but we will probably have to wait until the new Chancellor’s first Budget to find out about any other tax measures and whether there is any appetite for simplification. 

2. Tackling downstream non-compliance

Labour also plans to invest £555 million per year in additional resources for HMRC. The plan appears to be to primarily tackle downstream non-compliance (i.e., after a taxpayer has submitted their tax return) by “segments with the greatest complexity and return”. This will, in particular, include large businesses, given the scale of potential errors having a greater effect – which makes some sense. Given the smaller population of large businesses (2,000) than small businesses (5.2 million) (see HMRC’s Corporate Report for 2022/23), the tax gap per capita is much higher for large business (£2.15 million) than small (£4,600). However, large businesses are amongst the most compliant taxpayer populations and the disproportionate contribution of small businesses to the tax gap should not be ignored (and there are signs that Labour may also be looking to address this – see below in relation to upstream compliance). 

Other proposed downstream measures are to ring-fence amounts as ““blockbuster” funding to be used on strategically important criminal cases” to “bring back a strong deterrent where it is needed” and focus on offshore tax compliance. HMRC’s tax-gap figures do not currently consider “UK residents’ failure to declare offshore income”. A separate report is expected to be published this summer (the 2022/23 tax gap statistics mention that “HMRC plan to publish this analysis after the election period”), and it is expected that the Labour government would then assess “what dedicated capacity for offshore tax compliance HMRC needs”

3. Supporting upstream compliance

A part of the additional annual funding of £555 million would be used to support taxpayers correctly calculate the tax due (i.e., upstream compliance) which Labour’s Closing the Tax Gap document notes would be a better use of resource in respect of certain taxpayer populations, such as small businesses. Technological improvements (financed through the additional £300 million per year for HMRC’s capital budget) would also be intended to help with this. Proposal include upgrading HMRC’s IT infrastructure and developing greater pre-population of tax returns and digital correspondence mechanisms for taxpayers to seek advice.

Improving upstream compliance is important given that 45% of the UK’s tax gap is attributable to unintentional errors. In its review of HMRC performance in 2022/23, the House of Commons Committee of Public Accounts noted that HMRC customer service was at an all-time low. Customer support channels were being closed to prevent taxpayers contacting them for advice due to a lack of funding. So, it’s likely that taxpayers would welcome improvements to HMRC’s customer service.