How we provide an estimate of the amount of revenue not collected through non-detection and the shadow economy.
Overview
As highlighted in Australian tax gaps – overview, our gap estimates must be complete. This means they must account for both known and unknown factors.
To achieve this outcome, we have invested in 2 broad sub-programs to quantify the dollar value of factors relating to both – non-detection and the shadow economy.
Each of these sub-programs within the tax gap program have a significant level of complexity. The definition of each sub-program, and what they are attempting to estimate, are detailed below.
Non-detection
Non-detection factors are applied to bottom-up estimates that draw on compliance data to ensure factors outside our control are accounted for. For example, it is right to assume that during an audit, not every dollar of missing tax will be identified and recovered. If this correction is not applied, it leads to the estimate understating the true extent of the gap.
We also understand that perfect data is an unrealistic assumption. We know that the data we use or collect is imperfect or limited, and the processes used to analyse the data are not guaranteed to capture all errors, or the full extent of the errors identified. Imperfections or limitations can include partial and full omissions, errors, misallocations, and even deliberate falsehoods.
Systemic errors that relate to the gap estimate not reflecting the full system or population are considered separately, outside the definition of non-detection. We normally use separately estimated factors to correct for this type of error and adjust the estimate directly. For example, the estimate for people outside the system in the small business tax gap sits in this category of error correction.
Addressing non-detection
Our current estimates draw on both internationally accepted uplift factors as well as judgment-based factors drawn from experts in the field. Each gap estimate covers its approach separately to ensure each estimate is complete in terms of the holistic philosophy of tax gap.
Our estimates of the elements of non-detection error will continue to be developed and refined over time, using a range of methods. We consider that the development of tailored non-detection multipliers based on Australian data would enhance our non-detection methodology.
Shadow economy
In our previous releases, we provided tax gap estimates for 'the black economy'. For tax gap purposes, we now refer to this as the 'shadow economy', in line with other jurisdictions internationally. Although these terms are often used interchangeably, the term shadow economy is more commonly recognised when referring to tax.
We recognise shadow economy impacts as defined in the Black Economy Taskforce final report. This is based on the OECD definitions which includes illegal activity as well as economic activities that are productive and legal but are deliberately concealed to avoid payment of taxes and compliance with regulations.
Internationally, these amounts are more broadly referred to as estimates of the shadow economy, which more correctly reflects the tax effect of this economic activity.
It is important to understand that not all tax gap estimates are related to shadow economy activity. Where we have identified a tax gap as having a regular and consistent shadow economy impact, we separately identify this amount. For gaps with identified shadow economy impacts, the remaining tax gap would be attributable to errors that are not deliberate in nature.
A portion of shadow economy activity is already incorporated (indirectly) into existing gap estimates. Where it is not accounted for, we have committed to undertake further work to improve the credibility of our tax gap estimates. Our focus is on identifying the tax effect of the shadow economy – that is, taxes lost because of this activity.
Key impacts of the shadow economy relating to our tax gaps are:
- people outside the system
- people inside the tax system who under-report income
- accounting for hidden wages
- illicit activity impacting the excise system.
A summary of the shadow economy gap is included in Australian tax gaps – overview, with additional gap-by-gap summaries in the methodology section of each gap estimate.