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The concept of the "tax gap" has been widely studied and discussed by various nations and institutions to measure tax compliance. However, due to the complexity of tax gap measurement and the diversity of tax gap classification methods, its definition may vary significantly across sources. In this article, we provide a variety of tax gap definitions and describe the most popular methods that are applied to the VAT gap, and used by such institutions as the European Commission, International Monetary Fund, the UK His Majesty Revenue and Customs (HMRC), and the United States Agency for International Development (USAID).
The United States is losing $1 trillion in unpaid taxes every year, Charles Rettig, the Internal Revenue Service commissioner, estimated in 2021. President Biden has developed a comprehensive plan to reduce the tax gap that the Treasury Department estimates would raise $700 billion over ten years. The plan has three interdependent components: people, computer systems, and information. The information reporting component of the plan includes six essential points.
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.
The difference between the amount of taxes due and the amount collected is the tax gap. The reason for a tax gap may be accidental errors and ignorance of one's tax obligations, or deliberate understatement and non-payment of the accrued amount. The latter qualifies as an illegal business activity or tax fraud. Regardless of the cause of a tax gap, all the factors described contribute to the loss of national budget funds.
Digital Tax