The coalition’s weakness on the tax gap creates an opening for Labour

By Dan Hogan / @Hoganist

When the headlines are all about the latest obligatory ‘crackdown’ on benefit fraud ‘muggers’ – “unacceptable at the best of times and totally immoral” in the current circumstances, according to George Osborne – it’s easy enough to forget about the other, far more serious kind of unacceptable and immoral fraud, costing the taxpayer billions of pounds a year: tax dodging.

And yet, Osborne’s description of benefit fraud on the Andrew Marr show this morning is exactly the same as the terms in which both he and the Lib Dems’ Treasury secretary, Danny Alexander, framed the problem of tax evasion to their party conferences. Here’s what Alexander had to say to the Lib Dems:

“Just as it is right to ensure that every benefit claim is fully justified, so we must ensure that every tax bill is paid in full. There are some people who seem to believe that not paying their fair share of tax is a lifestyle choice that is socially acceptable. Not true. Just like the benefit cheat, they take resources from those who need them most. Tax avoidance and evasion are unacceptable in the best of times but in today’s circumstances it is morally indefensible.”

Those are fine words about a big problem. HM Revenue and Customs estimates that the ‘tax gap’ (the difference between what tax revenue ought to be, and what it is) to be £42bn. That’s a conservative estimate by all accounts, and independent research commissioned by the PCS union puts the gap at a huge £123bn a year. When we’re faced with a £155bn budget deficit, there are surely billions that can be clawed back from tax dodgers to help bring down that figure. Why not start by making the government’s advisor on Whitehall waste pay his fair share? That would put a £500m dent in the deficit straight away.

So, the announcement that the government is committed to raising an extra £7bn a year in recovered tax evasion, to a five-fold increase in criminal prosecutions of tax dodgers, and £900m of reinvestment in HM Revenue and Customs to make it all possible, should all be welcome, right? At last, it seems like the government recognises the scale of the problem, and the need for a solution.

Not quite. Start to pick at the details, and the coalition’s proposals quickly unravel. Firstly, it doesn’t help their case that the Treasury secretary and the chancellor can’t even agree what the problem is. In his conference speech, Danny Alexander spoke of tax avoidance and tax evasion in the same breath. He is right to do so: the difference between them is legally grey, and HMRC itself increasingly sees them as different heads of the same beast. But Osborne’s speech is subtly different to Alexander’s:

“Nor will we tolerate tax evasion. It is unacceptable at the best times; it too is morally indefensible in times like these.”

Unlike his Treasury second-in-command, the chancellor’s only concern appears to be the £7bn that HMRC estimates is lost each year to tax evasion, not the other £19bn a year lost to tax avoidance, loopholes, and crime. Tax evasion is only one-sixth of the £42bn tax gap. Tackling one sixth of the tax gap without doing anything about the rest is like building only one sixth of a dam.

If avoidance doesn’t figure as a problem in Osborne’s worldview, it also dampens hopes that the law around tax avoidance might be tightened up. In Labour’s early days of government, ambitious plans to bar any transaction motivated by tax avoidance never saw the light of day. A law to force accountants to inform HMRC of ‘marketed’ tax avoidance schemes stopped short of revealing bespoke schemes designed for specific clients, leaving a whole web of unregulated tax avoidance below the revenue’s radar.

This should be the perfect time to dust off those half-hatched laws. But when Sir Philip Green is advising the government on Whitehall waste and Lord Aschroft is funding the primary governing party the government looks intensely relaxed about people getting filthy rich through tax avoidance, to paraphrase Peter Mandelson.

The government also doesn’t know what it wants. It wants an extra £35 recovered for every extra £1 spent on investigation, but it also wants a five-fold increase in criminal prosecutions of tax evaders. The 35:1 ratio is possible, but only for the most specialist tax inspectors, investigating complex, high-value avoidance schemes. But that can’t happen if the extra £180m a year the Treasury is investing is spent preparing complex and expensive court cases against small time evaders: tax credit cheats and small businesses.

The problem is that HMRC’s most efficient investigations, in terms of tax recovered to money spent, are also the most complicated. These investigations can recover 250 times their costs but almost never become criminal cases, their complexity being well beyond the comprehension of most juries. Instead, they are heard in civil courts, where only a judge needs to understand the facts put before them.

It’s only the simplest and clearest-cut cases of tax evasion, against small-fry tax dodgers that are worth making into criminal cases, not the blue whales of the multi-billion pound avoidance industry. Even those cases are incredibly costly and time consuming for the amount of tax recovered. Making matters worse, the government is merging the agency responsible for prosecuting these cases, the Revenue and Customs Prosecution Office, with the Crown Prosecution Office, oft-criticised for being overly bureaucratic and inefficient. With only £900m over five years, with a £3bn cut over the same period, HMRC can’t possibly meet both the target for prosecutions and the target for recovering tax. For Osborne and Alexander to claim otherwise is either wishful thinking or plain deception.

Inevitably, it is funding that is the biggest obstacle. Shrinking the tax gap is made virtually impossible by the shrinking resources of HMRC. Even while this extra £900m is put into the revenue’s investigative apparatus, the organisation’s overall operating budget is to be cut by 25%. Half of its £4.8bn budget is staff costs, and cuts will inevitably mean that tax inspectors, along with their decades of training and experience, will be lost. Reducing HMRC’s budget will cost more money in unrecovered tax than it saves many, many times over. Labour has little to be proud of either: the Revenue has already lost 25% of its budget in the past five years, and has shed 30% of its staff.

As the Revenue finds its resources pinched further and further, accountants and their clients will become ever more brazen in the face of the diminishing risk of repercussion. The case needs to be made that cuts at HMRC threaten the viability of the UK’s tax base, the government’s ability to pay for everything from the NHS to defence.

Osborne and Alexander are right to compare tax fraud to benefit fraud, the only fundamental difference being the scale to which the Treasury and honest taxpayers lose out. But their half-hearted and ill-considered proposals to deal with the problem will only go a very short way towards closing the tax gap, and more won’t be done without public and political pressure. 38 Degrees is already running a campaign to urge the government into doing more, and if as much attention were given to tax fraud as there is to benefit cheats, this could be just as important an issue in the public mind.

This creates an opportunity for Labour. Proposing alternative budgets in opposition is a risky business, and Labour shouldn’t resist every cut. But challenging the government, with serious measures: tightening the laws it should have in 1997; investing real money into tax investigation; continuing Alistair Darling’s moves to close down overseas havens, could force them either to act or to explain why it is so relaxed about a problem that costs us tens of billions of pounds every year. With a surgical deconstruction of the government’s weak position, like at Ed Miliband’s PMQs debut, this has the potential to be a popular crusade, as well as a moral one.

Update: This article has been amended. An earlier version referred to tax planning, but was amended to make clear the difference between tax planning and tax avoidance.