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  • Methodology

    The individuals not in business tax gap estimate is derived through applying a bottom-up random enquiry approach. Random sampling methods are considered highly credible, best practice, and are commonly used by international jurisdictions to estimate tax gaps for this type of population.

    There are four steps in applying the random enquiry program bottom-up methodology to estimate the individuals not in business income tax gap. These steps are expanded on below followed by a summary of the overall estimate:

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    Step 1: Estimate unreported amounts and extrapolate to population. Apply estimate for people outside the system

    In each year we draw on a bundled sample of up to three years from the random enquiry program. The bundled sample is split into two key groups:

    • those that are progressed to manual review
    • those that are verified.

    We combine the incidence rates and means from these two groups. We then extrapolate to the population of individuals not in business to estimate the unreported tax liability.

    Additionally, we estimate the impact of people outside the system (non-registration or non-lodgment). This estimate draws on comparisons of Australian Bureau of Statistics (ABS) Census of Population and Housing (census) data to tax return data to estimate the number of non-lodging individuals who are not in business. We then estimate a dollar impact drawing on the random sample data to determine the final amount. We discuss this further in Limitations.

    Step 2: Estimate for errors not detected

    We apply an uplift to the unreported tax liability estimate to correct for errors not identified through the random enquiry program. The uplift factors are based on the midpoint of international ranges and account for non-detected amounts relating to:

    • income misreporting
    • deductions and other issues.

    We also apply an uplift for non-detected amounts that relate to hidden wages, consistent with our wider program for wages. We discuss this further in Limitations.

    Step 3: Estimate for non-pursuable debt

    We add in the value of non-pursuable debt. This is debt that the Commissioner of Taxation has assessed as being not legally recoverable, uneconomical to pursue, or unable to be pursued due to another Act.

    Debt trends show that it takes upwards of five years for non-pursuable amounts to crystallise (or be considered finalised) in any one financial year. As a result, we add a provisional amount of non-pursuable debt to the actual amount recorded in the most recent four years, based on historical amounts.

    Step 4: Consolidate the gap estimates

    The gross gap is calculated by adding the unreported amounts from Steps 1 to 3. The net gap is calculated by subtracting the total amendment amount from the gross gap. The net gap is then added to the tax paid to estimate the total theoretical liability. Both net and gross gap ratios are derived by dividing the dollar amounts by the theoretical liability.

    Summary of the estimation process

    Table 5 provides a summary of each step of the estimation process and the results for each year.

    Table 5: Summary of estimation process for individuals not in business income tax gap

    Step

    Description

    2013–14

    2014–15

    2015–16

    2016–17

    2017–18

    1.1

    Estimate unreported amounts and extrapolate to population (m)

    5,774

    6,782

    7,178

    7,167

    7,292

    1.2

    Apply estimate for people outside the system ($m)

    86

    119

    113

    88

    65

    2.1

    Apply estimate for non-detection (excluding hidden wages) ($m)

    122

    170

    199

    164

    154

    2.2

    Apply estimate for hidden wages ($m)

    1,210

    1,308

    1,366

    1,413

    1,411

    3

    Estimate for non-pursuable debt ($m)

    178

    181

    181

    181

    181

    4.1

    Estimate the gross gap (by adding together the results of Steps 1 to 3) ($m)

    7,369

    8,560

    9,037

    9,013

    9,102

    4.2

    Subtract compliance outcomes and voluntary disclosures ($m)

    823

    801

    707

    833

    770

    4.3

    Net gap ($m)

    6,547

    7,759

    8,330

    8,181

    8,332

    4.4

    Add tax paid ($m)

    111,141

    118,588

    125,184

    128,643

    140,161

    4.5

    Theoretical liability ($m)

    117,688

    126,347

    133,514

    136,823

    148,493

    4.6

    Gross gap (%)

    6.3

    6.8

    6.8

    6.6

    6.1

    4.7

    Net gap (%)

    5.6

    6.1

    6.2

    6.0

    5.6

    Limitations

    The limitations associated with estimation of the individuals not in business tax gap are listed as follows:

    • The 2018 estimate uses two of the three finalised random enquiry program sample years. This will be updated in future estimates.
    • The precision of the tax gap estimate is limited by the sample size. Through the use of an ongoing bundled sample we seek to maintain suitable confidence intervals over time.
    • To reduce compliance costs for the taxpayer, materiality thresholds were applied at the data-driven review stage. However, if a case develops into a manual review, all items in the tax return are investigated regardless of value.
    • There is no independent data source that can provide a credible or reliable macroeconomic-based estimate (unlike for indirect taxes).
    • The 2013–14 financial year estimates do not account for the effect on offsets of adjustments to income and deductions. Where there are adjustments to income and deductions, the estimates reflect the change in tax on taxable income.
    • A further limitation of the random enquiry program, and similar programs undertaken by tax administrators in other jurisdictions, is uncertainty around the impact of the non-detection error. The enquiries undertaken do not discover the full extent of non-compliance.

    Accounting for non-detection in the gap

    Not all errors are detected through the random enquiry program. We account for these by applying a non-detection uplift to the unreported tax liability estimate.

    The three sources of non-detection for the individuals not in business income tax gap relate to:

    • income misreporting
    • deductions and other issues
    • hidden wages.

    The unreported tax liability is divided into the above elements, with an appropriate non-detection factor then applied to each portion.

    Table 6 shows a summary of the impact of non-detection on the tax gap for each of these elements.

    Table 6: Summary of the impact of non-detection on the individuals not in business income tax gap

    Source of non-detection

    2013–14
    ($m)

    2014–15
    ($m)

    2015–16
    ($m)

    2016–17
    ($m)

    2017–18
    ($m)

    Income misreporting (excluding hidden wages)

    106

    153

    159

    132

    109

    Deductions and other issues

    15

    18

    40

    32

    45

    Hidden wages

    1,210

    1,308

    1,366

    1,413

    1,411

    Total non-detection

    1,332

    1,478

    1,565

    1,577

    1,565

    Accounting for the shadow economy

    The shadow economy concerns economic activity not declared, which may be a result of attempts to avoid tax obligations. We account for the shadow economy in the individuals not in business income tax gap by considering the impacts of:

    • hidden wages
    • people outside the system
    • undisclosed business activity.

    Table 7 shows a summary of the impact of the shadow economy on the tax gap.

    Table 7: Summary of the impact of the shadow economy on the individuals not in business income tax gap ($ million)

    Element

    2013–14

    2014–15

    2015–16

    2016–17

    2017–18

    Hidden wages

    1,210

    1,308

    1,366

    1,413

    1,411

    People outside the system

    86

    119

    113

    88

    65

    Undisclosed business income

    0

    0

    0

    0

    0

    Total shadow economy impact

    1,296

    1,426

    1,480

    1,501

    1,476

    Confidence in the random sample findings

    A confidence interval quantifies the 'precision' of the estimate from a random sample relative to the true value from the population.

    A 95% confidence level is considered industry best practice in terms of statistical analysis. It is the most commonly used level by researchers, including Her Majesty's Revenue and Customs (HMRC) in the UK in its equivalent tax gap program.

    Using a 95% confidence level means we are 95% confident that the true value of the net gap for 2017–18 lies in the confidence interval 4.9% to 6.3%, or $7.2 billion to $9.4 billion. The upper and lower bounds of the 95% confidence intervals follow. The gap estimates we make public reflect the mid-point of the lower and upper bound estimates.

    Figure 5: 95% confidence interval – upper and lower bound estimates – individuals not in business income tax gap, 2013–14 to 2017–18

    Figure 5: Graph showing the confidence intervals for the individuals not in business income tax gap estimate. The trend result ranges from 4% to 7% at commencement to the results shown above.

    As the program continues, we expect to see the upper and lower bounds of the range to narrow as the total sample size increases.

    The estimate from the random enquiry program is not the only component of the individuals not in business income tax gap estimate. To establish the overall gap we also draw on operational data for specific compliance risk areas. For example, we looked at failure by employers to withhold tax and report wage income of their employees, the non-lodgment of tax returns and the non-payment of debts.

    We combined the operational and random enquiry program findings to produce an overall gap estimate.

    Updates and revisions to previous estimates

    This gap was first published in 2018 and has been revised three times on an annual basis. In 2019 we realigned the population and estimate to be consistent with the wider tax gap research program. All historically revised data points come in close to the original estimates but are marginally lower.

    Figure 6 displays the net gap from our current model compared to all previously published estimates.

    Figure 6: Current and previous individuals not in business income tax gap estimates, 2013–14 to 2017–18

    Figure 6: Graph displaying our previous and current net gap estimates at Table 1.

    The data used in Figure 6 is presented in Table 8 below.

    Table 8: Summary of published net tax gap percentages for individuals not in business, 2013–14 to 2017–18

    Gap release year

    2013–14

    2014–15

    2015–16

    2016–17

    2017–18

    2017–18

    5.8%

    6.4%

    n/a

    n/a

    n/a

    2018–19

    5.6%

    6.2%

    6.4%

    n/a

    n/a

    2019–20

    5.6%

    6.1%

    6.2%

    6%

    5.6%

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      Last modified: 19 Oct 2020QC 56246