Tax (Photo credit: 401(K) 2012)

Following on from my recent post on the Economics of Climate Change, i felt it necessary to research the fiscal angle and the impact of the Tax gap and its missing billions. The tax gap created by the shadow economy causes a loss to the treasury of sums greater than the total UK Health spending, as a percentage of GDP

When it was recently revealed how little tax companies including Starbucks and Amazon have paid in the UK, there was a public outcry and quickly convened parliamentary hearings.

The spirit of tax laws is that everybody contributes their fair share. The letter of the law is a human attempt at objectively defining rules for what “fair” is. Since “fair” is impossible to define and even subjective, then trying to define a subjective concept objectively is doomed to be flawed, and it is these flaws and the law of unintended consequences that are exploited by tax avoiders and evaders and is seen as common sense business practice in minimising tax liabilities. Of course to a degree that is correct however, abusing these flaws to grotesque extremes is only “common sense” if you are extremely short sighted !

 Starbucks for example sold something like 400m tons of coffee a year and paid almost no tax, while enjoying all the benefits that taxes pay for, including roads to transport that coffee, NHS and schooling of their workforce, policing that keeps order and protects their property and so on. Further, Starbucks are allegedly accused of “avoiding” paying the Living Wage, compared with the national minimum wage for adults requiring in many cases further state top-up for these individuals.

We’re not talking about being a bit clever, staying just under the thin line of the limit of the law; we’re talking about a massive and grotesque abuse of just about every detail …. The UK Treasury Minister recently described it as ‘morally repugnant’.

Moving on, and checking that i have copiously used the alleged phrase (he he),  it should be recognised that it is extremely hard to make a globally respected and watertight tax law where national governments cooperate equally. For example in  the Starbucks case, they paid so little tax because allegedly they didn’t make any profit.  Whooa….How?  Because losses occurred elsewhere in the world were written in the books in the UK.

 It makes perfect sense to tax companies less when they’re not making a profit to support struggling companies. Starbucks however is not struggling, healthy sales and profits were generated in the UK, they even said so a the Select Committee hearing recently – hold the line ….. ok, … over the past three years, Starbucks has reported no profit (despite describing the UK operation to investors as profitable !) , and paid no income tax, on sales of 1.2 billion pounds in the UK.

So how can you define the law so that it supports struggling companies but not companies raking in millions of profit every year, and which are kept out of the books and out of reach of the UK tax authority… Why should Britain forfeit tax monies for alleged losses incurred elsewhere?

The message is ringing out clear and loud, and that is that at a time of economic crisis we can no longer ignore the fact that tax evasion and tax avoidance undermine the very viability of the economy, and have without doubt helped create the current debt crisis that threatens the well being of millions of honest taxpayers for years to come.

For too long, and too often in the name of deregulation, successive UK governments have promoted ideas that have undermined effective regulation and the supply of meaningful accounts so that a company can be properly appraised upon its true economic activity. This has assisted to undermine tax revenues and led to significant tax fraud amongst even smaller businesses.

All destroy the effectiveness of markets and suppress its capacity to operate at anywhere near optimum. The government needs to better support honest businesses that want to compete on a level playing field where abuse of the tax system plays no part in their success

A touch deeper on Tax avoidance and evasion

To understand what might be done to tackle the issues of tax avoidance and tax evasion, the mechanisms used to undertake such activities need to be understood. Whilst not the purpose of this blog, i think it might be useful to highlight these mechanisms and the importance of transparency.

The basic structures used for the purposes of tax avoidance are different from those used for tax evasion.

This is because tax avoidance is, by definition, done through legal mechanisms where full disclosure of transactions takes place but where the outcome is not which was intended by a parliament or a tax authority. Generally exploiting ‘unintended consequence’ loopholes.

Tax evasion, on the other hand, involves at least some illegal misrepresentation of a transaction. This might be the complete non‐disclosure of a transaction contrary to the requirements of the law, or it might be the non‐disclosure of some part of the information needed to correctly appraise the transaction.

Judge Lord Templeman wrote:

A tax avoidance scheme includes one or more interlinked steps which have no commercial purpose except for the avoidance of tax otherwise payable, and can conveniently be described as artificial steps. A tax avoidance scheme does not leave the taxpayer any better or worse off but leaves the Revenue worse off.

And Lord Templeman noted in the same article, another judge (Lord Brightman) described tax avoidance schemes having the following characteristics:

First, there must be a pre‐ordained series of transactions; or, if one likes, one single composite transaction. This composite transaction may or may not include the achievement of a legitimate commercial (i.e. ) business end … Secondly there must be steps inserted which have no commercial (business) purpose apart from the avoidance of a liability to tax – not ‘no business effect’.

What is clear is that the tax avoider faces uncertainty when pursuing their activities. That uncertainty focuses mainly on taking the chance that either they may not be discovered to be tax avoiding or that if they are then the interpretation placed on the law that they seek to exploit is favourable to them.  The recent Glasgow Rangers football club  EBT tax case may be a very good example here. The risk of penalties arising as a result of their actions depends upon what the outcome of these risky situations might be.

On transparency, two terms that can be used to describe tax avoidance and evasion are ‘suppressed data’ and ‘identity disguise’.

Suppressed data refers to a situation where a person exploits current regulation to hide information from tax authorities. The use of tax havens is an obvious example.

Identity disguise refers to the alternative abuse of hiding information behind entities that the person cannot be shown to own or control. Of course the two can be combined and often are.

It is only when there is full transparency of information and available to all participants that optimal decisions can be made, for example on:

1. Where to invest the resources of a company for best return;

2. What prices to charge;

3. When to enter or exit a market;

4. Which portfolio of assets to hold within financial markets;

Transparency clearly increases the prospects for the highest overall real returns in both the real economy where goods and services are made and sold and in financial markets that meet the needs of commercial companies and individuals for capital and ultimately increasing tax yields.

Opacity therefore reduces the efficiency of those markets just as it reduces the tax yield of governments.

The Shadow economy and the cost of tax avoidance and evasion

The Shadow Economy can best be described as all market‐based legal production of goods and services that are deliberately concealed from public authorities for any of the following reasons:

 (1)  to avoid payment of income, value added or other taxes,

(2)  to avoid payment of social security contributions,

(3)  to avoid having to meet certain legal labour market standards, such as minimum wages, maximum working hours, safety standards, etc.


So, time then to look at some actual figures, using data from Tax Research LLP, and checked against HM Treasury 2009 figures.

 Data on the overall tax rate and government spending as a proportion of GDP, used for some comparison purposes, came from the Heritage Foundation, and for healthcare from the World Health Organisation report ‘World Health Statistics 2011’.

The following data excludes criminal activities such as burglary, robbery, drug dealing, smuggling, etc., from the estimates.

 Looking at the impact of the Shadow Economy as a percentage of GDP and Health Care in UK; the figures are rounded for this comparative purpose.

UK GDP:                                                                                            £ 1,400,000 million

Size of Shadow Economy:                                                              12.5%

Tax burden:                                                                                       34.9%

Size of Shadow Economy:                                                              £ 176,350 million

Tax lost as a result of Shadow Economy:                                    £ 61,550 million

Gov’t spending as proportion of GDP:                                         47.3 %

Health care spending as proportion of GDP:                              9.3 %

Tax lost as a proportion of tax income:                                         12.5%

Tax lost as a proportion of government spending:                      9.2%

Tax lost on shadow economy as % of Healthcare Spending:     46.9%

These figures highlight the significance of tax avoidance and evasion in the UK.

 The shadow economy of the United Kingdom is worth more than the total cost of the UK health care budget.

 Looking now at the UK deficit: (2010 data)

Annual deficit:                                                           £ 146,725 million

 Tax lost as a % of annual deficit:                          41.9%

 Gov’t borrowing :                                                      £ 1,128,650 million

 Years it would take tax lost to repay debt :          18.3 yrs

 Finally it is worth looking at the tax gap due to VAT shortfall which is generally attributable directly to tax evasion. The following data came from HMRC.

 Theoretical VAT Liability                           £ 155,700 million

VAT receipts                                                 £ 128,700 million

VAT gap                                                         £ 27,000 million

VAT gap as a share of liability                   17%

 The data clearly shows that tackling tax evasion could, in theory, entirely clear the annual deficit over a reasonably short period of years.

 This is also true for many of the EU’s member states, and more importantly, debt would cease to be an issue threatening the well being of hundreds of millions of people in Europe as a result.

Finally, it should be noted that some argue that reducing the tax gap during a period of austerity is an inappropriate course of action. Their argument is that all taxation reduces consumer demand in the economy and to therefore collect more tax at this time would reduce demand even more than is already happening and so increase the risk of recession in Europe.

This argument is partial, and false.

Whilst it is true that reducing tax rates is a mechanism for stimulating an economy during a recession because such behaviour should increase effective consumer demand. This is a policy that only works when a government deficit results and if it is pursued within a legitimate economy, and with the intention of delivering prosperity.

Ignoring tax evasion and aggressive tax avoidance is something very different indeed: that is turning a blind eye to criminality. That criminality does not increase demand; it reallocates the ability to consume from those who should enjoy it according to the democratic mandate, to those who are willing to participate in criminal activity.


References: Tax Research LLP, TUC report “The Missing Billions”

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