Tax Gap in Canada: A Conceptual Study

Executive Summary

 

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On April 11, 2016, the Government of Canada announced a historic investment of over $444 million to enhance the CRA 's ability to detect, audit, and prosecute tax evasion, both at home and abroad. At that time, the Minister of National Revenue also announced that the CRA would begin work to estimate the tax gap.

Broadly defined, the tax gap is the difference between the tax that would be paid if all obligations were fully met in all instances, and the tax actually paid and collected.

The tax gap is a complex concept that can be considered from a number of perspectives – domestic or international, by type of tax or taxfiler, or by form of non-compliance. A country's aggregate tax gap – that is all tax dollars lost through all forms of non-compliance – is, in reality, the sum of a number of smaller tax gaps, representing revenue lost to non-compliance with distinct types of taxes such as income taxes or value added taxes (VAT), or areas of non-compliance, for example unreported or under-reported income or non-payment of taxes owing.

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Tax gap estimation is a challenging task. Estimates should be (a) useful to taxpayers in better understanding what the tax administrator is doing and its effectiveness in undertaking those activities, and (b) relevant for a tax administration in improving compliance.

While there is generally no direct method for calculating the tax gap, it can be estimated, albeit with varying levels of precision. There are two main approaches used to develop tax gap estimates: top-down and bottom-up. Top-down methodology relies mainly on independent external data (usually national accounts data) to estimate the tax base, a figure that is then used to calculate a theoretical value of tax that should be paid and collected. Bottom-up methodology, on the other hand, uses a tax administrator's internal administrative data to estimate the amount of taxes theoretically owing.

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Countries around the world have started publishing tax gap estimates, including the United Kingdom, United States, Sweden, and Australia. Each of these countries takes a different approach and estimates different components of their respective tax gaps. Their experience can provide valuable insight into the benefits and challenges of tax gap estimation.

There are a number of challenges facing tax administrations undertaking tax gap estimation. The key challenge is access to the comprehensive and good-quality data necessary to produce estimates. A significant proportion of the tax gap involves unreported or under-reported income and assets and economic activity that are deliberately hidden from the government. As a result, many countries that publish tax gap estimates highlight their uncertainty.

Nevertheless, tax gap estimates, considered along with other information and intelligence on non-compliance, can provide insight into the overall health of the tax system and approximate the level of non-compliance with tax laws. They can also act as a guide for tax administrators and enhance the value of the intelligence held by a tax administration on the sources of non-compliance within the tax system.

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