The findings are revealed in a new research briefing by Dr Arun Advani of the University of Warwick and Centre for Competitive Advantage in the Global Economy (CAGE). HM Revenue and Customs will release this year's tax gap figures later this week.
Funding more tax audits by HMRC would bring in billions in extra revenue for the Exchequer, the CAGE report argues, estimating that each new tax auditor hired would bring in enough tax each year to pay their own salary and the wages of four extra NHS nurses.
The briefing, published today by the Social Market Foundation, reveals that:
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One in three taxpayers who complete a tax return underpay their taxes. That is more than three million people.
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The total value of tax underpaid via self-assessment is around £8 billion, almost as much as we spend on fire services, buses and nursery places put together.
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Most of that tax is owed by a very small minority of taxpayers: only 2% of self-assessment taxpayers, around 200,000 people, account for £4 billion of the underpayment. This is equal to almost one penny on the basic rate of income tax.
Dr Advani's report argues that it is important to distinguish between small errors made in good faith and large, deliberate underpayments. "While this might make us sound like a nation of cheats, most of these people owe relatively small amounts. It might be that some of these cases are genuine mistakes."
Dr Advani's research also reveals more about the characteristics of the people who underpay their taxes:
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Men are one and a half times more likely to under-report than women and – since on average they have higher incomes – they also underpay more.
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People of working age under-report more than pensioners, partly because pension income is harder to under-report than self-employment income.
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A quarter of people with property income under-report, but that quarter under-report more than half of the property income they receive.
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On average people in the top 20% of incomes owe about one and half times as much as those in the bottom 80% of incomes.
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Under-reporting is most prevalent in the construction, transport and hospitality industries, where more than half of taxpayers under-report. What's more, those in transport and hospitality who under-report do so substantially, missing out more than half their total income.
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Almost half of self-assessment filers based in Northern Ireland under-report.
Dr Advani studies the impact that HMRC audits of taxpayers' records can have on tax revenues and taxpayers' conduct. He finds that a programme of targeted audits would bring in significant "missing" revenue for the Exchequer, and improve the behaviour of taxpayers: people who have been audited report higher level of incomes for five to eight years after being audited, compared with people who weren't audited but could have been.
Dr Advani says that targeted audits of people whose characteristics suggest they are likely to be underpaying large sums would bring significant gains for the Exchequer. His "conservative estimate" suggests that targeted audits costing HMRC £2,500 bring in between £10,000 and £15,000 in additional tax.
But the number of audits carried by HMRC has been falling steadily for several years.
Dr Arun Advani comments on these findings:
"Few public policies offer better returns than four to one in only five years. With these revenues, the Treasury could pay each auditor's salary and the salary of four additional nurses as well. More money from the Treasury to do these valuable audits would reap significant rewards, paying for itself and bringing in additional funds."
"Cutting auditors is the hallmark of short-term thinking. It reduces current costs, while money from past audits keeps rolling in. But that is not a sustainable strategy."
Notes:
Dr Arun Advani is Assistant Professor in the University of Warwick's Department of Economics, and Impact Director at CAGE. He is also a Research Fellow at the Institute for Fiscal Studies.
ABOUT THE CENTRE FOR COMPETITIVE ADVANTAGE IN THE GLOBAL ECONOMY (CAGE)
CAGE is a research centre in the Department of Economics at the University of Warwick. Funded by the Economic and Social Research Council (ESRC), CAGE is carrying out a 10-year programme of innovative research. The centre's research programme is focused on how countries succeed in achieving key economic objectives such as improving living standards, raising productivity, and maintaining international competitiveness.
ABOUT THE SOCIAL MARKET FOUNDATION
The Social Market Foundation (SMF) is a non-partisan think tank. We believe that fair markets, complemented by open public services, increase prosperity and help people to live well. We are the Impact Partner for CAGE, helping ensure its work is recognised by policymakers at Westminster. The SMF is resolutely independent, and the range of backgrounds and opinions among our staff, trustees and advisory board reflects this.
