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  • Methodology

    The PAYG withholding gap is an estimate of the difference between:

    • the tax that should have been withheld by employers from salary and wages paid to employees according to the law (theoretical PAYG withholding), and
    • the actual amounts of income tax withholding from salary and wages we have received.

    We use a top-down approach to estimate the PAYG withholding gap. This method compares total individuals income tax withholding minus non-salary and wages withholding and theoretical PAYG withholding from salary and wages calculated using external economic data.

    The gap estimate is made on the basis of the law as applicable for the relevant financial year. New or recent law changes will not be reflected in gap estimates.

    The following information outlines the methodology we have selected to estimate the PAYG withholding gap. We detail our assumption, limitations, data sources and reliability rating as assessed by our independent expert panel.

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    Selecting the methodology

    Actual PAYG withholding revenue is calculated on an accrual basis. This matches revenue to the financial year in which the liability occurred, rather than to the financial year the revenue is received.

    In selecting a methodology, we researched and considered the full range of options available including ‘top-down’ and ‘bottom-up’ methods.

    We adopted a top-down methodology largely based on available data from the ATO and ABS. This is considered the most suitable method given the broad-based nature and size of the population.

    Applying the methodology

    We undertake a five-step process to estimate the PAYG withholding gap. The five steps are summarised in Figure 3 and then described in detail.

    Figure 3: Steps to estimate the PAYG withholding liability

    Figure 3: This image is a pictorial representation of the five calculation steps outlined in the text following this image. This image provides the names of the steps only.

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    Step 1: Estimate salary and wages subject to withholding

    To calculate the PAYG withholding gap, we start with external data on Compensation of Employees – salary and wages published by the ABS in its quarterly and annual Australian National Accounts. We adjust the data in the following way:

    • We apply an uplift factor of 1.2% to account for the black economy. In arriving at this uplift factor, we considered comparable international uplifts and conducted an analysis of the large amount of data from our interactions with employers and our compliance activities that focus on the black economy.
    • We subtract benefits and payments not subject to withholding. This includes payments in kind (fringe benefits tax), salary sacrifice into superannuation, employee share schemes, and defence exempt income.
    • The resulting amount is assumed to represent salary and wages subject to withholding.

    Step 2: Calculate the theoretical PAYG withholding amount

    In this step, we multiply the amount calculated in Step 1 by the average rate of withholding to calculate the withholding amount that should be reported and remitted to us.

    The average rate of tax withheld is calculated from tax return data for each year. It is the amount of tax withheld, from salary and wage income, over the total salary and wages type income.

    This provides us with the theoretical PAYG withholding amount that should be reported and remitted.

    Step 3: Calculate PAYG withholding received by the ATO

    In Step 3, total PAYG withholding received is calculated from ATO systems data. It is calculated on an accrual basis. Non-resident dividends, interest and royalty withholding tax amounts are excluded.

    We subtract other non-applicable amounts, namely non-salary and wage withholding amounts. These include personal services income for sole traders, tax withheld where an Australian business number (ABN) is not quoted, voluntary agreements, benefits and pensions. We are then left with PAYG withholding received minus excluded amounts.

    Step 4: Calculate the PAYG withholding net gap

    In Step 4, we subtract PAYG withholding received (calculated in Step 3) from the theoretical PAYG withholding amount (calculated in Step 2). We then add non-pursuable debt amounts (PAYGW liabilities which have been written-off after being deemed as irrecoverable at law or not economical to pursue) to determine the net gap.

    Step 5: Calculate the PAYG withholding gross gap

    Finally, we add compliance outcomes and taxpayer self-adjustments to the PAYG net gap to determine the PAYG withholding gross gap.

    Summary of the estimation process

    Table 2 shows the five steps to calculate PAYG withholding gap estimates (in dollar values), with the gross and net gaps as a percentage for the six financial years from 2011–12 to 2016–17.

    Table 2: Summary of estimation process (value) for PAYG withholding gap

    Step

    Description

    2011–12

    2012–13

    2013–14

    2014–15

    2015–16

    2016–17

    1.1

    Salary and wages ($m)

    642,893

    664,879

    686,956

    706,091

    727,140

    743,806

    1.2

    Black economy uplift (1.2%) ($m)

    7,715

    7,979

    8,243

    8,473

    8,726

    8,926

    1.3

    Earnings not subject to withholding ($m)

    28,396

    26,810

    26,960

    29,015

    29,840

    28,078

    1.4

    Salary and wages subject to withholding (A) ($m)

    622,212

    646,047

    668,240

    685,549

    706,026

    724,654

    2.1

    Average rate of withholding (B)

    0.237

    0.237

    0.239

    0.247

    0.249

    0.250

    2.2

    Multiply (A) and (B) to calculate theoretical liability (C) ($m)

    147,173

    152,886

    159,973

    169,308

    175,891

    181,130

    3.1

    Total PAYG withholding received ($m)

    142,859

    150,196

    157,399

    166,851

    174,281

    180,424

    3.2

    Subtract excluded amounts ($m)

    1,305

    1,355

    1,402

    1,622

    1,716

    1,795

    3.3

    PAYG withholding received minus excluded amounts (D) ($m)

    141,554

    148,841

    155,997

    165,229

    172,565

    178,629

    4.1

    Non-pursuable debt (E) ($m)

    557

    560

    574

    489

    545

    545

    4.2

    (C) minus (D) plus (E) to equal net gap (F) ($m)

    6,176

    4,604

    4,550

    4,568

    3,871

    3,046

    5.1

    Add compliance outcomes and taxpayer self-adjustments to net gap (F) ($m)

    1,060

    1,298

    1,390

    2,226

    2,321

    2,998

    5.2

    Equals gross gap ($m)

    7,237

    5,903

    5,940

    6,793

    6,192

    6,044

    5.3

    Gross gap (%)

    4.9

    3.9

    3.7

    4.0

    3.5

    3.3

    5.4

    Net gap (%)

    4.2

    3.0

    2.8

    2.7

    2.2

    1.7

    Note: The results provided in this estimate are considered to be preliminary due to being subject to revision, in line with the Australian National Accounts data sets administered and revised by the ABS.

    Limitations

    Our data for salary and wages from tax returns does not have the same definition as the salary and wages series produced by the ABS. While we make adjustments to improve consistency, there are some items in the ABS data series we cannot quantify. The main variances are:

    • Individuals earning under the tax-free threshold are not required to lodge a return. While a significant number of people earning income under the threshold do lodge tax returns, some wage and salary data will be missing. This will affect the average tax rate we apply.
    • We do not have data on changes in provision for future entitlements, such as long service leave.
    • While we have tax expenditure statement estimates for tax-exempt Australian Defence Force payments and allowances, this does not include the value of food, clothing and travel.
    • We are uncertain about the number of individuals under voluntary withholding agreements or labour hire arrangements where they are classified as employees.

    We use ABS Australian National Accounts data to estimate theoretical salary and wages amounts. There are limitations with this approach, which means there will be a margin of error with the data. The limitations include:

    • sampling and non-sampling errors
    • National Accounts data is often subject to revision, which can vary historical trend results. Material revisions to this data will result in changes to the estimated PAYG withholding gap
    • non-measurement of the underground economy in relation to Compensation of Employees due to lack of sufficient data. We have added an uplift factor of 1.2% to account for this and ensure the gap is not underestimated.

    Some of the key assumptions of the methodology are:

    • When we remove identified income not subject to withholding from National Accounts data, the resulting amount represents salary and wages subject to withholding.
    • The average rate of withholding we apply to this data is appropriate.

    Updates and revisions to previous estimates

    Each year we refresh our estimates in line with our annual report. Changes from previously published estimates occur for a variety of reasons, including:

    • improvements in methodology
    • revisions to data
    • additional information becoming available.

    Figure 4 displays the gross gap and net gap from our current model compared to the previous estimates.

    Figure 4: Current and previous PAYG withholding gap estimates, 2010–11 to 2016–17

     Figure 4: This graph provides a visual representation of the current and previous PAYGW net gap estimates provided at Table 3

    Notes:
    The 2016 release lacked an uplift factor for the black economy.
    The differences between the current and previous estimates are mainly due to ABS data revisions.
    Table 3: Summary of published PAYG withholding net gap percentages

    Gap release year

    2010–11
    (%)

    2011–12
    (%)

    2012–13
    (%)

    2013–14
    (%)

    2014–15
    (%)

    2015–16
    (%)

    2016–17
    (%)

    2016

    2.9

    3.0

    2.1

    1.4

    na

    na

    na

    2017

    4.0

    4.1

    2.9

    2.7

    1.9

    na

    na

    2018

    4.3

    4.1

    2.9

    2.7

    2.6

    1.9

    na

    2019

    na

    4.2

    3.0

    2.8

    2.7

    2.2

    1.7

    Data sources

    To estimate the PAYG withholding gap we use a combination of ATO data and external data, such as:

    • ABS Compensation of Employees series and Salary and wages (cash or in kind) series from the Australian System of National Accounts
    • ATO data relating to actual salary and wages withholding.

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    Reliability

    Our estimate of the PAYG withholding gap has been assessed by an independent expert panel, as described in Principles and approaches to measuring gaps.

    Based on advice from the independent expert panel, the reliability rating for this estimate is medium.

    Data used to estimate the theoretical tax liability is largely based on external data sources. These are subject to revision and have historically impacted the most recent years of published gap estimates. We also incorporate an uplift factor to account for the black economy. Note: There is no official source for such estimates as highlighted by the final report of the Black Economy Taskforce.

    We will continue to refine our work on the PAYG withholding gap in future releases.

    Figure 5: Reliability rating scale from very low to very high – PAYG withholding gap

     Figure 5: This image is a graphical representation of the reliability rating for the current fuel excise gap estimate. It graphically represents a rating of medium, which is a score between 16 and 20. The maximum score is 30.

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      Last modified: 17 Oct 2019QC 57198