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  • Principles and approaches to measuring gaps

    Tax gaps are estimates of the difference between the amount of tax we collect and the amount we estimate we would have collected if every taxpayer was fully compliant. We use appropriate methodologies to calculate gap estimates across the range of taxes we collect.

    The process of gap estimation is technically complex and in essence, measures the unmeasurable. Our scope, methods, data and estimates will continue to evolve and revisions and restatements to the estimates are likely to occur in future releases.

    For each gap, we provide our current analysis for the year on that topic. This includes information about the specific methodology used, data sources and key assumptions. We also cover the limitations specific to each gap and the reliability of the estimate.

    On this page:

    Next step:

    • contact us at taxgap@ato.gov.au – if you require further detail or wish to provide feedback

    See also:

    How we measure tax gaps

    Our estimates aim to quantify the level of non-compliance across the four pillars of compliance – registration, lodgment, reporting and payment obligations. Where possible, we also estimate the amount of revenue not collected from those who do not register or lodge. Penalties and interest are not included in gap estimates.

    We have two measures of the gap:

    • The gross gap, which is the difference between
      • the amount voluntarily reported to us
      • the amount that would have been collected if every taxpayer was fully compliant (that is, the theoretical tax liability).
       
    • The net gap, which is the difference between
      • the total amount reported (the amount voluntarily reported to us, plus amendments as a result of compliance activities and voluntary disclosures)
      • the amount that would have been collected if every taxpayer was fully compliant.
       

    Tax gap concepts

    This diagram shows the tax gap concepts. We look at the amount voluntarily reported, amendments due to compliance activities and voluntary disclosure, and the amount not paid, against the theoretical tax liability.

     

    We estimate gaps for the year the economic activity occurred. They are historical and based on the law and the administrative approaches at the time they are calculated.

    Methodological approaches

    Our tax gap estimates are derived from a wide range of sources, including publicly-available information and ATO administrative data. Broadly, we apply either a top-down or bottom-up approach to estimating each gap.

    Ideally, though not always achievable, we use a combined approach. Each methodology complements the other and improves the accuracy and utility of the estimates.

    Top-down approaches

    Top-down approaches use externally-provided aggregated data sources to estimate the size of the tax base, from which we estimate the theoretical tax liability. The difference between the theoretical tax liability and the amount we receive is the estimated tax gap. A top-down approach is typically used for indirect taxes.

    Bottom-up approaches

    Bottom-up approached involve a detailed examination of data sources, such as tax returns, audit results (including random enquiry programs), risk registers or third-party data-matching information. We then extrapolate the results to determine the extent of non-compliance across the whole population, from which we estimate the tax gap. This approach generally involves applying statistical techniques to determine the incidence and value of non-compliance. A bottom-up approach is typically used for direct taxes.

    Random enquiry programs

    Random enquiry programs (REP) are a bottom-up methodological approach. It is a process for selecting tax returns for evaluation that ensures all tax returns have the same likelihood of being chosen.

    Usually, operational audit selection processes focus on taxpayers considered to have a high risk of non-compliance with a potentially large amount of tax at risk. Therefore, operational audit data is biased towards this 'high risk, high consequence' segment of taxpayers. In contrast, random selection avoids any systematic selection of segments of the population, and is designed to provide an unbiased representation of taxpayer information.

    Our two approaches to gap estimation

    This diagram shows our two approaches to gap estimation: The first approach is suited to indirect and volumetric taxes. It uses external aggregate data (for example, National Accounts data, industry data) and a top-down approach to calculate the theoretical tax liability. The second approach is suited to direct taxes. It uses internal administrative data (for example, random enquiry, compliance and illustrative data) and a bottom-up approach to calculate the gap sub-components, which are then extrapolated to the whole population.

    We choose the methodology that provides the most reliable estimate. In general, data availability and data quality are the key deciding factors for the approach used. We assess our methodologies for reliability to select the most appropriate methodology and to test our results.

    This table shows the broad methodological approach we currently use for each tax gap estimate.

    Gap estimate

    Methodological approach

    Fuel excise

    Top down

    Fuel tax credits (FTC)

    Bottom up – REP

    Goods and services tax (GST)

    Top down

    Individuals not in business income tax

    Bottom up – REP

    Large corporate groups income tax

    Bottom up – illustrative

    Large superannuation funds

    Bottom up – illustrative

    Pay as you go (PAYG) withholding

    Top down

    Petroleum resource rent tax (PRRT)

    Bottom up – illustrative

    Small superannuation funds

    Bottom up – REP

    Superannuation guarantee

    Top down

    Tobacco

    Bottom up

    Wine equalisation tax (WET)

    Top down and bottom up – REP

    Reliability assessment

    All gap estimates are assessed for reliability against ten criteria. The reliability rating provides a transparent assessment of our gap estimates, drawing on International Monetary Fund (IMF) and our expertise. We summarise this in a rating assessment for each gap estimate.

    In assessing reliability, we provide the expert panel with our initial views and working material. The expert panel assesses each submission and provides feedback for improvements. Once all feedback is addressed, the panel endorses a final score.

    Reliability criteria

    The ten reliability criteria are considered of equal importance. They are:

    Estimation framework – to what extent does the estimate:

    1. capture the appropriate tax base
    2. cover all potential taxpayers
    3. account for all potential forms of non-compliance
    4. avoid overlap between any two components of the framework.

    Methodology – to what extent does the estimate:

    1. meet IMF methodology criteria
    2. use multiple approaches that are validated internally and against accepted international standards
    3. sensitivity test for underlying changes in the model, structure and assumptions
    4. evaluate and assess assumptions, judgment or expertise used.

    Internal processes and delivery – to what degree is the estimate evaluated for:

    1. reliability and repeatability of data and documentation
    2. testing, evaluation and measurement against other sources, both internal and external.

    Reliability ratings

    For each estimate, each reliability criterion is scored from 0 ('does not meet in any way' and/or 'of poor quality') to 3 ('totally meets' and/or 'of excellent quality'). The sum of these scores determines the reliability rating.

    The total reliability score then ranges from 0 to 30 and is placed into one of four categories, as follows.

    • Very low (a score of 0 to 5) – The estimate results are preliminary or interim results, often being pilot estimates. The estimate will have a number of issues, such as incorrect population alignment or high sensitivity to assumptions. The estimate is not confirmed by other independent analysis. The results provide very little information and could be misleading.
    • Low (a score of 6 to 15) – The estimate has factors that are not considered. The estimation framework is often missing critical elements, such as black economy estimates. Critical unverifiable assumptions may be used. Estimates may be partially confirmed by other analyses. Improvements, when made, may significantly alter the gap estimates. The gap itself provides limited information.
    • Medium (a score of 16 to 25) – The estimate is in a more mature phase, with only a small number of factors not considered. Material assumptions are tested through qualitative or quantitative methods. Estimates are potentially derived from more than one calculation. The estimate can be corroborated with analyses, such as risk models and intelligence scans.
    • High (a score of 26 to 30) – The estimate has achieved a high degree of reliability. A high reliability rating is difficult to achieve in practice given the nature of what is being estimated and limitations in the underlying methodologies. All population factors are captured. The estimate is derived from more than one calculation and is confirmed by other analyses, such as risk models and intelligence scans.

    Voluntary compliance ratio

    The voluntary compliance ratio (VCR) complements gap estimates by measuring the proportion of taxpayers fully compliant with their tax obligations. Under the four pillars of compliance, there are four key taxpayer obligations covered by the VCR:

    • registration – taxpayers/entities are correctly registered, as required
    • lodgment – the required returns are lodged by the due date
    • payment – tax liabilities are paid on time
    • reporting – the correct amount of tax liabilities are paid.

    The VCR estimate is a cumulative assessment of compliance. Failure against one of the pillars counts as non-compliance in a taxpayer’s total tax affairs.

    Non-compliant taxpayers are removed from the starting population at each pillar, leaving a final compliant population, which is expressed as a percentage of the starting population. A taxpayer failing at any stage is considered non-compliant and is not tested for compliance at a later stage.

    The VCR measures the proportion of a population that meets all four obligations, expressed as a percentage of the starting population. We measure the VCR for both the number of taxpayers (taxpayer level) and the value level.

    Combining levels of correct registration, lodgment and payment on time, with gap estimates, provides an additional indicator of the value of revenue remitted by taxpayers without any direct intervention by us.

    We calculate the VCR for GST and wine equalisation tax (WET). The step-by-step methodology we use to calculate the GST VCR is provided in Goods and services tax gap. A similar methodology is used to estimate the VCR for WET.

    VCR – taxpayer level

    To estimate the VCR at the taxpayer level, we determine the number of taxpayers that voluntarily comply with all obligations, and then divide this by the number of taxpayers required to be registered under the law.

    The calculation is represented as:

    To calculate VCR at the taxpayer count level, divide the number of voluntarily compliant taxpayers by the number value of required taxpayers in the system.

    We also calculate an ‘adjusted VCR’ at the taxpayer level, which is not as strict as the above test. In the adjusted VCR calculation, taxpayers are assumed to be compliant if:

    • they have no total business income in the year (that is, all business activity statements are nil)
    • they only have one late lodgment of a business activity statement (BAS) and/or one late payment through the year.

    VCR – value level

    For the VCR at the value level, we sum the value of each compliant taxpayer’s tax as it moves through the four pillars of compliance. This amount is divided by the value of the tax expected under the law.

    The calculation is represented as:

    To calculate VCR at the tax value level, divide the value of tax voluntarily paid by taxpayers by the total value of theoretical tax.

    Reference material

    Glossary

    Term

    Meaning

    Accrual revenue

    Accrual revenue is based on the 'economic transaction method' and reflects the tax liabilities for the period in which an economic activity actually occurred. This approach facilitates comparison with economic events in the same period.

    Avoidance

    Tax avoidance occurs when taxpayers exploit the tax laws to gain an advantage. Such transactions generally serve no commercial purpose and are entered into merely to obtain a tax benefit that was not intended by parliament. The extent to which tax avoidance is included in the tax gap depends on whether it is contestable.

    Australian Bureau of Statistics (ABS)

    The ABS is the statistical agency of the Australian Government. It provides statistics on a wide range of economic, environmental and social issues, to assist and encourage informed decision making, research and discussion within governments and the community.

    Australian National Accounts

    Economic statistics produced by the ABS on income, expenditure and production in the economy.

    Black economy

    Often known as the 'cash economy' or 'non-observed economy'. Refers to the 'Economic Underground' boundary of an OECD framework. It involves economic activity not declared, which may be a result of attempts to avoid tax obligations. National Accounts data makes a small allowance for expenditure associated with the 'underground economy' (cash economy transactions, transactions relating to other avoidance measures, and understatement of income in ABS surveys).

    Business activity statement

    A business activity statement (BAS) is the form lodged by businesses on a monthly, quarterly or annual basis to report certain tax obligations, including fringe benefits tax, luxury car tax, wine equalisation tax and GST.

    Bottom-up approach

    A bottom-up approach is a detailed examination of specific data sources (typically individual tax returns through audit or review), to determine the extent of non-compliance across the whole population. The data sources can range from tax returns, audit data, risk registers or data matching. It includes random enquiries, data matching, operational data and illustrative methods. These methods are typically used for direct taxes.

    Compliance

    Compliance means in accordance with established legislation and the intent and spirit of the tax law.

    Compliance activities

    Direct interventions that we initiate to ensure taxpayers comply with their tax and superannuation obligations.

    Error

    Refers to mistakes made in submitting information to us, including when lodging a tax return. An error can be intentional or unintentional.

    Excise

    Excise is a tax on alcohol, tobacco, fuel and petroleum products produced or manufactured in Australia. Collectively, these products are referred to as excisable goods.

    Excise equivalent goods

    Imported alcohol, tobacco, fuel and petroleum products (including LPG, LNG and CNG) that are subject to duty are treated consistently with goods manufactured in Australia. These imported goods are referred to as excise equivalent goods (EEGs).

    Evasion

    The act of evading tax obligations. Tax evasion occurs when people break the law by not reporting all of their income, or dishonestly overstating deductions to reduce the amount of tax they need to pay. Examples of tax evasion include underreporting income, not reporting cash wages, not lodging tax returns or not paying employee superannuation entitlements.

    Excise clearance data

    The excisable units (litres, numbers or kilograms) of excisable products cleared for home consumption and reported by excise clients on their excise return.

    Failure to take reasonable care

    Failure to take reasonable care occurs when a taxpayer does not do what a reasonable person in the same circumstances would have done. Circumstances include age, health, knowledge and education.

    Fuel excise

    Fuel excise is a tax on fuel and petroleum products (excisable goods) produced or manufactured in Australia. Imported fuel and petroleum products are subject to customs duty at a rate equivalent to excise to ensure they are treated consistently with goods manufactured in Australia. These imported goods are referred to as excise equivalent goods (EEGs).

    Fraud

    Fraud refers to wrongful or criminal deception intended to result in financial or personal gain. This includes claiming tax refunds and money laundering, using false or stolen identities; claiming GST credits for goods or services that GST was not paid on, and claiming deductions for expenses not incurred or legally deductible.

    Gross tax gap

    The gross tax gap is the net gap plus the amount of revenue we raise and collect through our compliance activities.

    Luxury car tax (LCT) payable

    LCT payable is the amount of luxury car tax payable, as reported at label 1E on the business activity statement.

    Median adjustment

    The median adjustment is the midway point of all label adjustments made. The median differs from the mean, which is the arithmetic average (adding all adjustments and dividing by the number of labels adjusted). The reason we use median rather than mean is because it is a more accurate representation of adjustments, as it reflects the sample size being used. For example, a small number of large value adjustments will overstate the true value of adjustments in the sample.

    Net tax gap

    The net tax gap is the difference between theoretical tax according to the law, and actual tax paid voluntarily or collected as a result of compliance activities.

    Non-detection

    Some errors are not identified in bottom-up methodologies. To fully estimate the gap, we increase the amounts that we do identify to account for amounts we don’t. We refer to this increase as an 'uplift factor'. Non-detection is inherently difficult to estimate and we will revise the uplift factors applied as our methodologies improve.

    Non-payment

    Non-payment refers to debts to us that have been written off or are currently outstanding.

    Pay as you go (PAYG) withholding

    PAYG withholding is the value of income tax withholding payable by employers on employee salary and wages. Other withholding not from salary and wages (including non-resident interest, dividend or royalty withholding, no-ABN and no-TFN) are excluded.

    Petroleum resource rent tax (PRRT)

    PRRT is a profits-based tax that only taxes profits above a specified rate of return from the sale of petroleum resources. PRRT is not a royalty or a traditional income tax, but rather a tax on ‘rents’ in the sense of excess returns that only taxes assessable receipts when they exceed deductible expenditure on a project by project basis. PRRT will only arise when a project has recovered all eligible outlays associated with the project (after deducting eligible exploration expenditure transferred from other projects), including the achievement of a threshold rate of return on the outlays.

    Pillars of compliance

    The four pillars of compliance are: correctly registering in the system; lodging tax information on time; reporting complete and accurate information; and paying tax obligations on time.

    Random enquiry program

    A random enquiry program (REP) is a process for selecting tax returns for evaluation that ensures all tax returns have the same likelihood of being chosen.

    Tax gap

    The tax gap is an estimate of the difference between the amount of tax theoretically payable (assuming full compliance by all taxpayers) and the amount actually reported or collected for a defined period.

    Top-down approach

    A top-down approach uses independent aggregated data sources to estimate the size of the theoretical tax base. These methods typically are used for indirect taxes.

    Value-added tax (VAT)

    VAT is a tax on consumer spending. The tax is placed on a product or service when there is value added at the stage of production or at the final sale to the consumer. Each business in the supply chain charges VAT on their sales and is entitled to a refund of VAT paid on their inputs or purchases. Australia’s GST is a value added tax on goods and services for domestic consumption.

    Voluntary compliance ratio

    The voluntary compliance ratio (VCR) is an estimate of the proportion of taxpayers that voluntarily comply with their tax obligations under the four pillars of compliance.

    Wine equalisation tax (WET)

    WET is a tax on wine consumed in Australia. It is based on the value of the wine sold and generally applies to the last wholesale sale (usually between the wholesaler and the retailer) although it may apply in other circumstances.

    Acronyms and initialisms

    ABS

    Australian Bureau of Statistics

    ATO

    Australian Taxation Office

    BAS

    business activity statement

    EEG

    excise equivalent goods

    FTC

    fuel tax credits

    GST

    goods and services tax

    IMF

    International Monetary Fund

    LCT

    luxury car tax

    PAYG

    pay as you go

    REP

    random enquiry program

    VAT

    value added tax

    VCR

    voluntary compliance ratio

    VIN

    vehicle identification number

    WET

    wine equalisation tax

      Last modified: 13 Dec 2018QC 53168