Methods for Estimating the Tax Gap

Key Questions in Determining the Tax Gap

The method for determining the tax gap is quite simple. It answers two key questions:

What are we looking for?	How can we find it?
We are looking for taxpayers who either do not declare at all or declare an understated tax base.	We check whether a taxpayer filed a return and compare the data in the tax return with taxpayer information in the tax information systems and from third parties.

When determining the tax gap, the fundamental premise is that taxpayers may “play games” with the tax administration, hoping that it will not notice the understated tax base. But taxpayers that conduct business cannot hide from customers. On the contrary, they try to attract customer’s attention in every way to make more money.

Taxpayers earn money to save, invest, or spend. This means that a taxpayer’s activity leaves digital footprints. The tax administration’s task is to collect information from digital footprints and compare it with tax return data.

Digital Footprints

Digital footprints of organizations and individual entrepreneurs include the following data sources:

Organizations & Entrepreneurs

Individuals

Government registers on taxable objects. Information about business accounts opened in financial institutions. Cash receipts and account transactions to calculate the income, tax base and taxes. Registers of physical and virtual payment terminals. Issued licenses and permits for sales, signs, and visual advertising. Point-of-sale location data from the geographic information systems. Postings in yellow pages, classifieds, and other public advertisement resources. Context and banner advertising. Business transactions of the online digital platforms. Office leases and consumption of communication services, electricity, and other utilities

Information about purchases (expenses) based on data from fiscal cash registers. Government registers on taxable objects (real estate, land, vehicles). Account details from financial institutions. Information about transactions on personal accounts to calculate the income and tax base and to find business-related activities. Data from digital platforms and aggregators of goods, works and services, for example, data on renting out apartments.

The taxpayer may adjust some data over time. For example, receipts for returns and corrections may reduce the amount reported by fiscal cash registers reports and allow the correct calculation of the tax base stated in the tax return. A third party, such as a credit institution, can provide other data with responsibility for its accuracy.

Additionally, the owners of some data must provide it to the tax authorities on a regular basis. There is data that data owners must provide at tax authorities’ request, and there is data that tax authorities can collect from open sources independently, without taxpayers’ involvement.

Tax authorities should compel data owners to:

• Transfer it regularly and fully.
• Identify their customers and link the provided data to their tax ID.

Tax administrations will find it incredibly challenging to receive and process massive amounts of source data with the necessary level of accuracy if they do not complete this task, which will not please taxpayers or data owners.

On the other side, if taxpayers understand that data about them is available to the tax authorities, the natural result is greater compliance, voluntary reduction of the tax gap, and an increase in tax collection.

There is a risk that entrepreneurs will switch to cash to hide transactions from authorities. To control the situation, tax administrations need to:

• Analyze the share of cash payments in their countries.
• Comprehensively assess this risk.
• And motivate buyers to make cashless payments.

Restricting cash payments can be a useful, though not popular, option.

Data and Algorithms for Identifying the Tax Gap

The minimum set of information that enables the tax gap minimization includes taxpayers’ registration and accounting data, tax returns, fiscal cash register reports, and data from financial organizations, ideally with detailed statements of accounts and transactions. This information empowers the following methods for identifying the tax gap.

#	Task	Algorithm for Analyzing the Tax Gap	Source of the Tax Gap
1	Analyze fiscal cash register data on revenue adjustments.	Analyze fiscal cash register data and look at the share of revenue, adjusted based on receipts for returns and adjustments. Next, identify those who have minimized their tax base and look at the difference in fiscal cash register data relative to the tax base stated in the tax return. Look at a median adjustment compared to taxpayers with similar activities.	Understatement of the tax base and paid tax, depending on the taxation system.
2	Analyze fiscal cash register data for unique employees.	Analyze fiscal data from the cash register and identify how many employees the taxpayer has. Compare with data on the payment of income tax and insurance premiums for employees.	Payment of wages in cash, informal employment, underpayment of income tax and insurance premiums.
3	Analyze fiscal cash register data for cashless payments	Analyze fiscal cash register data for cashless payments and check whether the taxpayer has bank accounts.	Acceptance of cashless payments at a payment terminal owned by another taxpayer. Non-compliant use of fiscal cash registers, understatement of the tax base and paid tax, depending on the taxation system.
4	Analyze settlement account transaction data to identify payment processing transactions.	Identify the payment processing transactions on a bank account and compare them with fiscal cash register data on cashless payments and with the tax base in the tax return.	Failure to use fiscal cash registers for cashless payments, failure to issue fiscal receipts. Understatement of the tax base and amount of paid tax, depending on the taxation system.
5	Analyze fiscal cash register revenue.	Get revenue based on fiscal cash register data and compare it with the tax base in the tax return.	Understatement of the tax base and paid tax, depending on the taxation system.
6	Analyze exceeded limits for special tax regimes.	Get revenue from fiscal cash register data, determine the tax regime, and compare the maximum actual revenue with the threshold in terms of the tax gap.	Violation of the tax regime’s requirements and failure to pay other taxes when income exceeds the regime’s limit.
7	Analyze financial transactions to calculate the tax base.	Ensure continuous receipt of transaction data for the tax period, attribute transactions to the tax base, and calculate the taxpayer’s tax base. Next, calculate the tax base for cash payments based on fiscal cash register data, perform calculations, and compare the result with the tax base specified in the tax return.	Understatement of the tax base and paid tax, depending on the taxation system.

When conducting the analysis, pay attention not only to taxpayers who file a tax return but also to those who do not.

For taxpayers who file a tax return and understate the tax base, there are existing office audit processes that should incorporate procedures to minimize the tax gap.

For taxpayers who do not file a tax return, tax authorities usually simply block transactions on bank accounts and expect the taxpayer to accept guilt and file a tax return.

Regrettably, this rarely happens, and a significant part of the tax gap remains open. We recommend paying close attention to this problem and constantly develop, evaluate, and improve the tax gap minimization methods.