Pressure on Labour and Conservatives as tax gap hits £40bn

The gap between tax revenue the UK government expected to raise and the amount paid annually has hit £40bn, putting extra pressure on both main parties over their pledges to crack down on tax avoidance.

HM Revenue and Customs (HMRC) said there was a shortfall of £39.8bn in the 2022-23 financial year, up from £38.1bn a year earlier. This represents 4.8% of the amount of tax theoretically due, down from 5.2% in the previous financial year.

Richard Murphy, a tax expert, said the assessment of tax losses to the exchequer was “seriously underestimated” and that Labour’s plans would not improve the situation. He said the amount of tax not being collected could be closer to £100bn.

Labour has promised to target tax dodgers. In April the shadow chancellor, Rachel Reeves, said she would cut the difference between money owed and actual receipts, known as the tax gap, by £5bn by the end of the next parliament, by investing £555m in new HMRC staff and modernising systems.

HMRC estimates that 32% of the corporation tax owed by small businesses is not paid, amounting to lost revenues of almost £11bn, making this group accountable for the greatest share of unpaid tax.

However, Labour’s plans target the wealthy, Murphy said, and do nothing to address tax avoidance among small businesses. “The tax abuse scandal is among white-van men,” he said. “But politicians don’t want to hear that as white-van man lives in their constituency.”

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In its manifesto, Labour has promised to raise £565m a year by closing the carried interest “loophole”. Under these plans, profits made by private equity managers would be taxed as income at a rate of up to 45% plus national insurance, rather than capital gains, which has a lower rate of 28%.

In March the chancellor, Jeremy Hunt, scrapped tax breaks for non-domiciled residents – foreign nationals who live in the UK to avoid paying tax on their overseas income and gains.

Labour has also said that it would remove tax exemptions enjoyed by private schools, adding VAT to fees at the standard rate of 20%. The plans have been blamed for parents paying years of private school fees upfront to avoid VAT using advance payment schemes.

Rachael Griffin, a tax and financial planning expert at Quilter, said simplifying the tax system could have a much greater impact. “The stability of the tax gap over recent years underscores the need for radical change to ensure that the public coffers are refilled following this difficult economic period,” Griffin said. The gap has dropped by only 1.7% in a decade.

Griffin said significant problems within the system remained. “If Labour does win the general election, then unlocking additional tax revenue from fixing the leaking system is certainly possible,” she said. “But whether it’s realistic in a short timeframe is less likely.”

The increasing absolute value of the tax gap is due to year-on-year growth in theoretical tax liabilities of about 15% annually, from £738.7bn in 2021-2022 to £823.8bn in the last financial year.