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  • Why we measure the tax gap

    Estimating tax gaps forms part of our broader accountability and transparency as a leading administrator. It is consistent with contemporary international best practice in tax administration.

    Australians all benefit from healthy tax and superannuation systems that support our society and economy. The community expects us to manage all aspects of the systems, including advising on the tax gaps and what we are doing about them. As such, we measure and publish tax gaps, where they are credible and reliable, to inject our perspective into the community debate.

    Tax gap estimates are also important for us to better understand levels of compliance and risk in the tax and superannuation systems, to inform our resource allocation, and to assess the effectiveness of our work over time.

    Tax gaps are an indication of the system in operation. The insights gained from this analysis guide us in determining priority risks and development of strategies, including administrative design, help and education, and audit strategies.

    Tax gaps internationally

    Other administrations also measure tax gaps, including:

    • Her Majesty’s Revenue and Customs (HMRC) – United Kingdom
    • Internal Revenue Service (IRS) – United States
    • Danish Customs and Tax Administration (SKAT)
    • Canada Revenue Agency.

    The European Commission (EU) uses external researchers to identify the value-added tax (VAT) gap in each of its 28 member countries, providing trends over time. The International Monetary Fund (IMF) provides support to jurisdictions in estimating tax gaps.

    Our gap measurement methodologies draw on the experience of the above contemporary administrations to ensure our estimations meet best practice. We also share our tax gap information with our counterparts in HMRC and the IRS.

    Engagement, advice and assurance

    In developing our estimates, we engage key stakeholders and subject matter experts within the ATO and the community, including tax gap experts, researchers, academics, government agencies and taxpayer representative groups.

    Work with our broad range of advisors and stakeholders, on refining our methodologies and developing approaches to estimating other tax gaps, is ongoing.

    Holistic view of the tax gap program

    There are three main principles to the tax gap program; the outcomes from gap estimation need to be:

    • reliable
    • credible
    • meaningful.

    Each of the principles listed above provide us with a framework that we have codified in our reliability assessments for each estimate.

    Reliable

    For the reliable principle, we assess ourselves against two main outcomes:

    1. Trustworthy
    2. Dependable

    For an outcome to be trustworthy, the outcome needs to be transparent, concise and open to evaluation and critique. To achieve a dependable outcome, the estimate needs to use the best practice methods available. The results from those methods need to be repeatable, and the results must be evaluated by experts.

    Credible

    For the credible principle, we assess ourselves against the two outcomes of:

    1. Believable
    2. Complete

    For the credible principle, an outcome is believable when it explains why the gap is the size it is, and what the wider issues and impacts are. To be complete the outcome needs to cover all the bases; this includes all associated issues and the black economy.

    Meaningful

    For the meaningful principle, we assess ourselves against the two outcomes of:

    1. Explained
    2. Communicated

    This last principle ensures the outcomes that are obtained through our estimates are more than just numbers on a page. This principle looks to ensure that our stakeholders are able to understand and engage with us in an informed conversation about the tax and super systems. Therefore, an outcome is explained if it answers the why questions. It identifies the contributing factors of a gap, the key risks and drivers, as well as acknowledging the caveats and limitations of the estimate. Lastly, all this information must be communicated. Effective communication means it can be used by stakeholders to inform strategy and treatment plans, and to understand the health of the system.

    Two of the three principles of the tax gap program are externally assessed by our expert panel to provide us with an independent assessment of our effectiveness at achieving the above principles. The third principle of meaningful is assessed internally to ensure the reliable and credible outcomes have appropriate context, and are therefore meaningful to the intended audience.

    Independent expert panel

    Recognising the importance of having reliable and credible tax gaps, we engage an independent expert panel to provide advice on the suitability of our gap estimates and methodologies. The panel was established in 2013.

    The panel’s advice considers:

    • whether proposed methodologies can be relied on to produce a sufficiently robust gap estimate
    • whether the methodologies are likely to be broadly accepted as a way of estimating a gap and whether alternative methodologies should be considered
    • international comparability, including global developments in the use of tax gap estimation methodologies and practices.

    The panel currently comprises:

    • Neil Warren – Professor of Taxation, School of Taxation and Business Law, University of New South Wales. Neil is a respected economist, specialising in public sector economics with a special focus on taxation policy and fiscal federalism. Neil has received several grants, organised numerous conferences and consulted widely, preparing reports for state and federal government agencies. He has provided expert opinion to government inquiries and parliamentary committees, and advice to political parties and welfare and industry groups. Neil has been a member of the panel since 2013.
    • Richard Highfield – a highly experienced tax professional having worked within the fiscal areas of the International Monetary Fund (IMF) and the Organisation for Economic Co-operation and Development (OECD). Richard has a wealth of experience in both domestic and international taxation. He is an adjunct professor with the School of Taxation and Business Law, University of New South Wales, and has been a member of the panel since 2013.
    • Saul Eslake – an independent economist, and vice-chancellor’s fellow at the University of Tasmania. Saul has decades of experience in the Australian financial markets, and has been previously employed as Chief Economist at ANZ, Bank of America Merrill Lynch, and National Mutual Funds Management. Saul joined the panel in 2017, following the stepping down of Chris Richardson.

    We look to the expert panel to review our detailed methodology and provide independent assessment on it, and on the reliability rating for each of our tax gap estimates. Reliability ratings provide a transparent assessment of our gap estimates.

    Addressing the gap

    Our focus on prevention (before correction) influences the gross tax gap and drives it down. To focus just on correction would influence the net gap only.

    We take this into consideration as we continue to refine and develop the range of strategies we employ to manage tax gaps.

    Our primary strategy is to make it as easy as possible for Australians to comply with their tax obligations. We look at this from many perspectives:

    • enhancing our digital services
    • improving our processes and technology, including our data-matching capability
    • providing advice to government, via Treasury, where we see law reform options
    • working with partner agencies and stakeholders to improve the tax and superannuation systems
    • providing guidance and advice to clarify areas of uncertainty, including issuing Taxpayer Alerts if we see potential risks
    • dealing with non-compliance, including investigating aggressive tax planning.

    Tax gap research program

    The diagram below shows the various tax gaps that form our overall gap research program, within the context of the Australian tax and superannuation systems.

    The gaps are grouped into three programs of analysis:

    • transaction-based tax gaps – for taxes collected and paid by an entity higher up in the supply chain (with the cost generally borne by the consumer), such as goods and services tax (GST) and fuel excises
    • income-based tax gaps – income tax (for both individuals and businesses), large and small super funds, and fringe benefits tax gaps
    • administrative gaps – non-tax gaps, including for pay as you go (PAYG) withholding, superannuation guarantee and other administered programs.

    The relationship between the various gaps is complex. While some are mutually exclusive, some are closely related or form subsets within the established gap estimates. For example:

    • work-related expenses, levies, rebates and concessions are subsets of the income-based tax gaps for small business and individuals
    • some gaps arise through employment – employment-related gaps include PAYG withholding, superannuation guarantee and fringe benefits tax (for individuals).

    In addition, the black economy manifests in a number of gap estimates. For example, unreported income is included in individuals not in business, small business, PAYG withholding and superannuation guarantee. The black economy affects these gaps to varying degrees.

    These complexities demonstrate why the gap estimates cannot be aggregated into one figure.

    Tax gap research program overview

    This graph is a visual representation overview of the tax gap research program as discussed in the tax gap research paragraphs. It groups the gap estimations into their respective groups: transaction-based (such as GST), income-based (such as large corporate groups income tax), and administrative gaps (such as PAYG withholding). It also shows how the black economy touches on some of the gap estimates, such as GST, Individuals income tax and PAYG withholding.

    How to use the estimates

    The tax gap estimates should be viewed as trends over time, in conjunction with our performance measures. The dollar value is indicative rather than definitive.

    All estimates have a margin of error, which may not be quantifiable. The estimates are subject to limitations and caveats that need to be considered when using them and drawing conclusions. These limitations are explained in Principles and approaches to measuring gaps.

    Gap estimates should not be aggregated into one figure or divided by annual ATO collections, or other aggregated revenue amounts.

    Summary findings

    In October 2018, we updated our estimates for goods and services tax (GST), wine equalisation tax (WET), fuel excise, pay as you go (PAYG) withholding, and fuel tax credits (FTC). We are in the process of refreshing our estimates and anticipate the next updates will be published in October 2019.

    We have also added new gaps: superannuation guarantee and large corporate groups income tax in 2017 and Tobacco and Individuals not in business income tax in 2018.

    We continue working towards developing tax gap estimates for all of the taxes and programs we administer.

    The following is a summary of our latest gap estimates in alphabetical order (note that the latest data varies depending on the particular gap).

    • Fuel excise gap – the net fuel excise gap is estimated to be $326 million (1.9%) in 2015–16. The excise products covered in this estimation are concentrated in an industry with a small number of large taxpayers who we have generally observed to be highly compliant.
    • Fuel tax credits – the net fuel tax credits gap for 2016–17 is estimated to be −$19 million (−0.3%). This reflects our findings from random enquiries that suggest the under-claiming of fuel tax credits exceeds the over-claimed amounts. This result is consistent with previous estimate outcomes.
    • GST gap – the net GST gap estimate for 2016–17 has trended slightly downwards from previous years to $5.26 billion (7.9%). This fall is largely driven by a notable contraction in the contribution by taxable household consumption to the theoretical liability for the year. In other words, households are spending more money on GST free goods and services such as food, health and education. Australia ranks relatively well among similar nations that have estimated GST/VAT gaps.
    • Individuals not in business income tax gap – for 2014–15 we estimate a net tax gap of $8.76 billion (6.4%). Analysis shows the main components driving the gap include incorrect claims for deductions for work-related expenses and omitted income particularly in relation to undeclared cash wages. Another contributor is deductions for rental property expenses.
    • Large corporate income tax gap – in 2014–15, the net large corporate income tax gap is estimated to be $2.5 billion (5.8%). This trend has been steady for a number of years, and the gap primarily reflects differences in the interpretation of complex areas of tax law.
    • Large super funds – in the 2015–16 year the net large super fund gap is estimated to be $127 million (1.5%). Analysis shows the main drivers of this gap are over claiming of the foreign income tax offset, incorrect application of CGT provisions and over claiming of franking credits.
    • PAYG withholding gap – the net PAYG withholding gap estimate for 2015–16 is $3.36 billion (1.9%). This suggests that employers are generally compliant with their withholding obligations. We estimate that employers are paying about 95% of the PAYG withholding they are required to without intervention from us.
    • Small super funds – for the 2014–15 year, we estimate the small super fund net tax gap to be $39.9 million (3.2%). The analysis shows main drivers of this gap to be misunderstanding in the application of exempt current pension income (ECPI) provisions, incorrect reporting of franking credits and over-claimed deductions.
    • Super guarantee gap – for 2015–16, we estimate the super guarantee gap to be $2.79 billion. This represents 4.8% of the total estimated $56.77 billion in super guarantee employers were required to pay. In 2015–16, superannuation funds reported to us that employers paid $54.31 billion in super guarantee. This represents 95% of our adjusted theoretical super guarantee amount.
    • Tobacco tax gap – for the 2015–16 year, the net tobacco tax gap is estimated to be $594 million (5.6%). Our analysis indicates that sea and air cargo is the most significant source of detected illicit tobacco entering Australia.
    • Wine equalisation tax gap – in the 2015–16 WET estimate, we included the payable and refundable WET amounts to generate a net WET gap estimate. The net WET gap estimate for 2015–16 is $5 million (0.5 %). This is consistent with our observations of compliance within the WET system.

    Our latest net gap estimates (both as a dollar value and percentage) are shown in the tables below. The tax reported and reliability assessment of each estimate are also shown.

    Net tax gap estimates – direct and indirect taxes, latest available data

    Tax gap estimate

    Reliability assessment

    Financial year

    Amount reported ($m)

    Net gap ($m)

    Net gap (%)

    Fuel excise

    Medium

    2015–16

    16,891

    326

    1.9

    Goods and services tax

    Medium

    2016–17

    60,962

    5,264

    7.9

    Individuals not in business income tax

    Medium

    2014–15

    128,410

    8,761

    6.4

    Large corporate groups income tax

    Medium

    2014–15

    40,728

    2,526

    5.8

    Large superannuation funds

    Medium

    2015–16

    8166

    127

    1.5

    Small superannuation funds

    Medium

    2014–15

    1215

    39.9

    3.2

    Tobacco

    Medium

    2015–16

    9,928

    594

    5.6

    Wine equalisation tax

    Medium

    2015–16

    896

    5.0

    0.5

    Note:

    • We are in the process of refreshing our estimates and anticipate the updates will be published in October 2019.
    • All figures are rounded to the nearest $1 million.
    • Changes from previously published estimates are due to revisions to ABS data, updated ATO data and a modified approach to determining liabilities reported but not paid. The beer excise and duty gap estimate has been withdrawn due to identified issues with data.
    • Net gap percentage is calculated as net gap divided by estimated total tax with full compliance (that is, tax reported plus the gap).
    • For 2013–14 and prior years, the estimate is for WET payable only, not taking into account wine producer rebates.

    Tax reported gap, as a dollar value and percentage, for each of our gap estimates for selected administered programs, for the latest year data is available.

    Net tax gap estimates – administered programs, latest available data

    Tax gap estimate  

    Reliability assessment

    Financial year

    Amount reported ($m)

    Net gap ($m)

    Net gap (%)

    Fuel tax credits

    Medium

    2015–16

    6,089

    −19

    −0.3

    PAYG withholding

    Medium

    2015–16

    173,481

    3,356

    1.9

    Superannuation guarantee

    Medium

    2015–16

    54,309

    2,790

    4.8

    Note:

    • We are in the process of refreshing our estimates and anticipate the updates will be published in October 2019.
    • All figures are rounded to the nearest $1 million.
    • Changes from previously published estimates are due to revisions to ABS data, updated ATO data and a modified approach to determining liabilities reported but not paid.
    • Net gap percentage is calculated as net gap divided by estimated total tax with full compliance (that is, tax reported plus the gap).
    • The latest available year for the PAYG withholding gap estimate is 2015–16.
      Last modified: 13 Dec 2018QC 53161