The tax gap folly: Are we going too far?

Rachel Reeves has announced new measures in both the 2024 Autumn Budget and the November 2025 Budget aimed at reducing the fiscal deficit, following widespread speculation about potential tax increases.

As HMRC and HM Treasury continue to focus on raising tax revenues, the concept of the “tax gap” has become increasingly central to public finance discussions. But what exactly is the tax gap? How large is it in the UK today? How has it changed over time? How does the UK compare to other countries? And what are the potential risks of pushing too hard to close the gap — and the unintended consequences that may follow?

What is the tax gap?

HMRC defines the tax gap as “the difference between the amount of tax that should, in theory, be paid to HMRC, and what is actually paid.” In practice, this includes revenue lost due to tax evasion (deliberate fraud), tax avoidance (legal but aggressive planning), errors and carelessness, legal interpretation disputes, non-payment (such as insolvency), and the hidden economy (unregistered activity).

HMRC publishes annual “Measuring Tax Gaps” reports, expressing the gap both in cash terms and as a percentage of theoretical tax liabilities. Crucially, HMRC and HMT acknowledge that a 0% tax gap is impossible — some level of unpaid tax is inevitable in any system. The tax gap is therefore best understood as a strategic indicator of system health, rather than a performance target.

Current level of the UK tax gap

As of the 2023–24 tax year, the UK’s tax gap is estimated at 5.3%, equivalent to approximately £46.8 billion in lost revenue. This means HMRC successfully collected around 94.7% of all tax theoretically due.

The composition of the gap is revealing. According to HMRC’s breakdown for 2021/22, around 45% of the gap stems from taxpayer errors or carelessness. Evasion accounts for roughly 16%, the hidden economy around 5%, criminal attacks 9%, and non-payment due to insolvency or other reasons about 6%. Tax avoidance — often the focus of public debate — now contributes less than 1% of the gap.

By taxpayer group, small businesses account for the largest share, while large businesses and wealthy individuals contribute a smaller portion. This suggests that the tax gap is not driven by a few high-profile cases, but by a long tail of small-scale non-compliance.

How has the UK tax gap changed over time?

Over the past decade, the UK’s tax gap has declined significantly. In 2013–14, it stood at 6.9% of theoretical liabilities. By 2017–18, it had fallen to a record low of 5.1%. Since then, the gap has plateaued, fluctuating between 5.1% and 5.6%, with the latest figure for 2023–24 at 5.3%.

This trend suggests that most of the “easy wins” have been realised. Improvements in digital reporting, targeted enforcement, and anti-avoidance legislation have helped reduce the gap. However, further reductions are likely to be incremental and harder to achieve, particularly as the remaining gap consists of more intractable issues such as the hidden economy and tax debt from insolvent businesses.

How does the UK compare internationally?

International comparisons must be made cautiously, as definitions and methodologies vary. Nonetheless, available data indicate that the UK’s tax gap is among the lowest in the world.

In the United States, the IRS estimates a tax gap of around 13–15% of liabilities. Canada and Australia report gaps in the region of 7%. Italy’s gap has historically been in the range of 15–19%. The European Union’s average VAT gap is around 7%, with some member states exceeding 20%.

By contrast, the UK’s 5.3% gap places it at the lower end of the spectrum. This reflects the strength of the UK’s tax administration, the prevalence of third-party reporting (such as PAYE), and relatively high levels of taxpayer trust and voluntary compliance.

Is there a structural floor to the tax gap?

While no official OECD benchmark exists, literature and data suggest a realistic lower band of 3–7% for advanced, trust-based tax systems. OECD VAT gaps rarely fall below 2–3%, and IMF studies show that even the best systems miss around 1.5–2% of GDP in tax.

Academic consensus points to diminishing returns below 5%. As the gap shrinks, the cost of enforcement rises, and the marginal gains become harder to justify. HMRC itself acknowledges that some gap is inevitable due to insolvency, error, and hidden activity.

The UK’s current level of 5.3% is therefore consistent with this structural floor. It suggests that the UK is already operating near the frontier of what is realistically achievable without fundamental changes to the tax system.

How does the UK compare to that benchmark?

If we accept the 3–7% range as a plausible structural floor, the UK’s 5.3% gap sits comfortably within it — and closer to the lower bound than the upper. This indicates that the UK is performing well by international standards.

Further reductions would require significant investment, systemic reform, or technological innovation. While desirable, such reductions may not be cost-effective, and could risk unintended consequences if pursued too aggressively.

Expert commentary and policy implications

Experts from across the tax and policy landscape broadly agree that the UK’s tax gap is low and stable. The Chartered Institute of Taxation (CIOT) describes the gap as “stubborn” and unlikely to fall sharply. TaxWatch UK emphasises that HMRC’s role is to manage the gap, not eliminate it. Financier Worldwide notes that “the reality of any tax system is some gap is inevitable.”

Policy priorities should therefore focus on:

• Supporting small businesses with simplification and guidance
• Investing in digital tools and data analytics
• Targeting the hidden economy and offshore evasion
• Avoiding over-reliance on enforcement alone

Public perception often overestimates the role of avoidance, which now accounts for less than 0.1% of the gap. The real challenge lies in addressing widespread but low-level non-compliance.

Risks of over-enforcement: When closing the tax gap goes too far

While reducing the tax gap is a legitimate policy goal, there is a growing recognition that overly aggressive enforcement or compliance policy can have unintended consequences — particularly for legitimate businesses operating in good faith.

Efforts to close the tax gap often involve increased reporting requirements, more frequent audits, stricter penalties for errors, and complex digital compliance systems. For small and medium-sized enterprises (SMEs), these measures can translate into higher costs, administrative complexity, and uncertainty. Businesses may feel they are being treated as suspects rather than partners — especially when compliance systems are rigid or poorly implemented.

This can lead to reduced appetite for entrepreneurship, delayed investment decisions, reluctance to expand or hire, and a chilling effect on innovation. In short, the compliance burden can become a drag on productivity and growth, particularly if it is disproportionate to the actual risk posed by the taxpayer segment.

There is also a behavioural dimension. If HMRC’s approach becomes too punitive or intrusive, it may erode the trust that underpins voluntary compliance. Taxpayers who feel unfairly targeted may disengage, seek aggressive tax advice, or even move operations offshore. Overly broad anti-avoidance rules may catch legitimate commercial arrangements. Retrospective policy changes can undermine confidence in the stability of the tax system. Excessive scrutiny of R&D claims or transfer pricing may deter inward investment.

In a globalised economy, businesses have choices — and perceived hostility from the tax authority can make the UK less attractive as a place to do business.

Finally, there is the question of cost-effectiveness. As the tax gap shrinks, the marginal cost of enforcement rises. Chasing the last 1–2% of unpaid tax may require disproportionate resources — and those resources could arguably be better spent elsewhere, such as improving taxpayer services, simplifying legislation, or supporting digital transformation.

The OECD and IMF have both cautioned against treating the tax gap as a performance target. Instead, they advocate for balanced strategies that weigh revenue gains against economic impact.

Conclusion

The UK’s tax gap is well-defined, closely measured, and relatively low by international standards. At around 5%, it reflects a high level of compliance and effective administration. While further reductions are desirable, they are likely to be incremental and costly. The “3–7%” range often cited in literature appears to be a realistic structural floor, and the UK is already operating within it.

Policymakers should remain vigilant against overreach — ensuring that efforts to close the gap do not inadvertently stifle legitimate business activity, investment, or innovation. The goal should be smart, targeted improvement — not perfection at any cost.