What is the Tax Gap and Why Does it Exist?

TheTax Gapoccurs in almost all economies because of both legal and illegal activities; it is the difference between the amount of tax that a country's tax authorities believe they should be able to collect and how much they actually do collect. In some countries, such as the UK, it is a relatively low figure in percentage terms, most recently standing at 6.8 per cent. But in others, such as the US and, particularly, Italy it can reach as high as almost 30 per cent.

There are a number of reasons why there is a tax gap:

• Individuals and companies not paying what they should, either by mistake or through deliberate tax avoidance schemes that are not illegal but neither are they in the spirit of paying a fair share of tax.
• Individuals or companies with a recognised tax debt that they are having to pay off over a long period of time.
• Tax evasion whereby individuals or companies deliberately and knowingly seek to illegally reduce their tax liabilities.

There are a number of different ways that the tax gap can be calculated but it is fraught with uncertainty and there is often disagreement between tax authorities and other bodies over the exact figure for a particular country. Differences in estimates of the tax gap due to different calculation methods can run into the tens of billions of pounds in the UK. That said, the UK tax authorities have had their method approved by the International Monetary Fund (IMF) and regularly alter it in a bid to make it more accurate.

Certainly in the UK there have also been significant improvements in clamping down on "legal" tax avoidance schemes that twist the rules, but illegal tax evasion is on the rise and accounts for 5 times more of the tax gap than tax avoidance. There is also the matter of the so-called "hidden economy" – illegal activities under the radar of the tax authorities, which are difficult to produce estimates for because they are an unknown quantity.

Although tax gaps can constitute significant amounts of money that could be put to good use within an economy,in many countries it is still only a small minority of individuals and companies that do not pay what they owe.

It is important to distinguish between tax avoidance, that is not strictly illegal, and legitimate tax planning, which takes advantage of all available tax reliefs to minimise a tax bill. The best way to be sure that you are not paying too much tax is to talk to alondonaccountants or a professional tax advisor. Pension schemes, inheritance tax planning and individual savings accounts (ISAs) are examples of legitimate tax planning.Other ways for individuals to minimise their tax burden is to ensure you are making full use of the tax reliefs available to married couples and those in civil partnerships, which can be very beneficial if one half of a couple is a lower rate tax payer and the other is a higher rate tax payer. Similarly assets that, when sold, could incur capital gains tax can be held in tax-efficient ways.

The author has written and published articles on a wide range of topics including Small Business Advice, Tax and Accounting, Interior Design, House Renovation and Project Management.