UK VAT Gap

1. UK VAT Gap Mick Thackray Knowledge, Analysis & Intelligence HM Revenue & Customs September 2009

2. Outline • Estimation of the UK VAT Gap • Results • The VAT Gap in HMRC’s administration of VAT: costs & benefits • Discussion of current trends & conclusion

3. Estimation of the UK VAT Gap

4. Our approach to calculating the VAT Gap Five main stages for top-down approach: • Assess the total amount of expenditure in the national economy that is theoretically liable for VAT (‘VAT theoretical tax liability’ – VTTL) • Estimate the VAT liability on that expenditure (gross VTTL) • Deduct any legitimate reductions - schemes and reliefs (net VTTL) • Subtract actual VAT receipts • Residual element = Total VAT loss (assumption) VAT Gap Net VAT Theoretical Tax Liability (VTTL) Actual VAT Receipts - =

5. Household (consumer spending) VTTL Housing Exempt Charities Government We identify five components within VTTL

6. Estimating households’ contribution to VAT • Largest component of VTTL (about two-thirds) • Can allocate almost all spending directly to the correct VAT liability Data modelling • Office for National Statistics (ONS) quarterly Consumer Expenditure series • Based on household Expenditure & Food Survey • Adjusted for cross-border shopping and tourist spending • Disaggregated to product level • Allocate VAT rate to product type (no averaging) • Sum for total expenditure • Adjustments for small residuals Relatively small margin of error............

7. A mixture of rates in consumer spending Source: ONS ‘Consumer Spending’, 2008 data

8. ‘Stuck VAT’ in intermediate consumption Three main types of exempt expenditure: • Businesses making VAT exempt supplies cannot reclaim VAT on the related inputs • Expenditure subject to input tax blocking orders – business cars, hospitality • Expenditure by businesses trading below the VAT threshold UK exempt supplies dominated by finance and insurance sectors • Data source - ONS, HMRC • Expenditure breakdown from ONS Supply-Use tables • Proportion of recoverable inputs estimated from HMRC survey • Input tax blocks estimated from DFT, ONS and other data • Small traders’ numbers & turnover derived from BERR and distribution analysis Most complicated sector…..

9. Other sources of net receipts Government Departments • VTTL and VAT receipts are net of refunds to Government Departments • Supply-Use tables for detailed breakdown 2-3 years in arrears • surprisingly volatile series...... Housing • Capital expenditure (ONS data) Charities • Non-profit making bodies, membership organisations & universities • Uncertain figures, sporadic data collection • Least contribution to VTTL • Expenditure broken into Input-Output commodity groups using ONS survey

10. How the components of VTTL add up

11. Some further adjustments to make …. • Adjust VTTL to account for • Schemes and reliefs (eg small consignment relief) • Litigation impacts (eg three year cap) • Policy measures • Isle of Man revenue sharing arrangement • Timing effects (+/- ½ pp) • VAT amounts are subtracted from Gross VTTL to obtain Net VTTL Overall, adjustments making a big difference, [c.2-3pp], to final results …..

12. And now the easy(-ish) bit: receipts • HMRC consolidated fund (cash receipts) • Assumed three month lag between accrued VAT liability and collection (based on accounting arrangements) • Calendar year VTTL compared to receipts in following financial year • Adjusted for Government refunds

13. The final answer: Net VAT Theoretical Tax Liability (VTTL) VAT Gap Actual VAT Receipts - =

14. Results

15. How has the UK done in recent years? Source: Measuring Indirect Tax Gaps – 2008, HM Revenue & Customs (NB: mid-range MTIC estimates)

16. In the longer term …. Results 1990/91- 2007/08 VAT gap VTTL VAT receipts

17. The VAT Gap is only an indicator of levels

18. The VAT Gap in HMRC’s administration of VAT: costs & benefits

19. How does HMRC use the VAT Gap? • Monitoring VAT losses & non-compliance consistently • over time • across behaviours • Measuring performance against HM Revenue & Customs’ Departmental Strategic Objective 1 (DSO1): “Improve the extent to which individuals and businesses pay the tax due…” • Forecasting VAT receipts • Policy analysis and costings

20. What’s good about the UK VAT Gap • Use mainly National Accounts data so largely independent • Will pick up all losses – holistic analysis of VAT base and losses • Robust measure of trend over time • Links performance plans to revenue forecasts, receipts and fiscal risk • Allows operational effectiveness to be isolated from externalities • Progress to the target monitored in real time • Drives greater precision in economic analysis • Allows more sophisticated models • forecasting future receipts • costing policy options

21. What the VAT Gap costs • Heavy initial investment – both analysts and tax specialists • Ongoing cost – one full-time equivalent statistician per year • Exempt sector particularly time-consuming But …. • Resources allocated are a function of value, ie use • Simpler, less precise versions can be a fraction of cost • Is updating in real-time required? Can be uncomfortable for stakeholders to live with ……..

22. Discussion of current trends & conclusion

23. Is the recession affecting the VAT Gap? • Can’t tell you (sorry - Official Statistics code of practice) • But receipts are doing this: • And we know that debt is an issue ….

24. Summary The UK VAT Gap is not rocket science • A pragmatic, robust measure of losses • Though detailed in execution, it is conceptually simple • Embeds tax performance in policy and operational models • Embeds compliance and performance at the heart of VAT analysis • Appreciable development and maintenance costs, but • Reliable, real-time indicator of significant change (+/- 0.5pp?)