Who does and doesn’t pay taxes?

Arun Advani

This IFS Briefing note uses data from HMRC’s random audit programme to show which types of people are more likely to be under-reporting taxes and how their behaviour changes after a tax audit. The results are based on data from audits covering tax returns for the years 1999–2009.

Key findings

• Every year, 10 million people file income tax self-assessments, around a third of all UK taxpayers. Using a sample of these who were randomly audited, we can learn about non-compliance among all self-assessment taxpayers.

• More than one-third of self-assessment taxpayers (36%) who were randomly audited were found to have errors in their tax returns that led to underpayments (‘non-compliance’). The average additional tax owed by the non-compliant taxpayers is £2,320, equal to almost one-third (32%) of the initial tax amount they declared

• HMRC has improved its targeting of non-compliant taxpayers, increasing the revenue raised per targeted audit conducted. However, the decline in the number of such audits reduced the total revenue raised from audits from a peak of £869 million in 2003, to just over a third of that by 2009.

• Most non-compliant taxpayers (60%) owe less than £1,000. A small number of taxpayers – less than 4% – owe more than £10,000, but they account for 42% of the missing revenue.

• Men are more likely to be non-compliant than women (40% versus 27%). However, among both men and women who are non-compliant, 32% of total tax owed was not declared.

• Non-compliance is greater among working-age individuals, at around 40% of those below state pension age (SPA), compared with only 21% of individuals above SPA.

• In part, this reflects the difficulty in under-reporting pension income compared with under-reporting self-employment income. 59% of taxpayers declaring only self-employment income were found to be non-compliant, compared with only 16% of those declaring only pension income. Surprisingly, 29% of those declaring only employment income were non-compliant, despite such income being also reported by employers.

• The likelihood that a taxpayer is non-compliant does not vary substantially with income. The cash amount of tax not reported by non-compliant individuals averages around £2,200 across all but the individuals with the top 20% of incomes. For those in the top 20%, with incomes above £47,270, it averages £3,530.

• Non-compliance is highest in the construction, transport and hospitality industries, where more than half of self-employed taxpayers were found to be non-compliant. In hospitality and transport, more than half of total tax owed was not reported.

• Random self-assessment audits recover an initial £830 per audit on average, since one in three audits yields a return and the average return among those is £2,320. Audits also bring in income for at least five years after the audit, by changing taxpayers’ reporting behaviour: being audited leads taxpayers to declare more income subsequently. This raises another £1,230, one-and-a-half times the initial gain.

• The longer-run gains come from the additional information HMRC acquires about audited taxpayers’ incomes. As this information becomes more dated, taxpayers again reduce their tax declarations.

• A reasonable estimate for the cost of an audit might be around £2,500. If correct then this would be slightly more than the total revenue raised from a random audit. But targeted audits can raise significantly more than they cost. For example, audits targeting those with the top 20% of reported incomes would have an average total yield of £10,870 per audit.