Tax Gap: A brief overview
In April 2016, the Government of Canada committed to estimating the federal tax gap and a dedicated unit was established at the Canada Revenue Agency (CRA) to examine and publish a series of reports analyzing different components of the tax gap.
The publication of tax gap estimates and methods provides information to the Government of Canada and the public on tax non-compliance and helps to deliver on the Government’s commitment to transparency. Understanding how and why taxpayers are non-compliant is critical to help preserve the integrity of the tax system and to protect Canada’s revenue base, which supports programs and benefits that improve the quality of life for all Canadians.
So far the CRA has published seven tax gap reports:
- a conceptual study (June 2016)
- Goods and Services/Harmonized Sales tax gap estimate (June 2016)
- personal income tax compliance in Canada (June 2017)
- tax compliance of individuals in the international context (June 2018)
- corporate tax compliance (June 2019)
- excise duties and taxes compliance (December 2020)
- payment tax gap (December 2020)
These reports, available on the Government of Canada’s website, provide detailed information on the CRA’s compliance efforts and describe the CRA’s tax gap estimation methods. Tax gaps estimated to date are presented in the table below.
Canada’s Federal Tax Gap Estimates Before Audit for Tax Year 2014 (excluding payment gap)
Note: All amounts are in nominal dollars.
The table has three columns and they are called ‘Tax Gap Component’, ‘Federal Tax Gap Estimate Before Audit’, and ‘% of Corresponding Revenues*’Footnote 1 . The first tax gap component is Goods and Services Tax, and its federal tax gap estimate is $2.9 billion after audit or 7.1% of the corresponding revenue. The second tax gap component is Domestic Personal Income Tax, and its federal tax gap estimate is $6.5 billion. The third component is International Personal Income Tax, and its estimate is between $0.8 billion and $3.0 billion. Together the Domestic Personal Income Tax and International Personal Income Tax gaps account for between 5.4% to 7.0% of the corresponding revenue. The forth tax gap component is Corporate Income Tax, and its tax gap estimate is between $9.4 billion and $11.4 billion or between 24% and 29% of the corresponding revenue. After audit results, the tax gap estimate for Corporate Income Tax is between $3.3 billion and $5.3 billion or between 8% and 13% of corresponding tax revenue. The fifth tax gap component is Excise Duty and Tax**Footnote 2 , and its tax gap estimate is $0.5 billion or 4.3% of corresponding revenue. The total tax gap to date is between $20.1 billion and $24.3 billion or between 9.2% and 11.2% of the total tax revenue.
Unlike previous tax gap estimates which tried to measure what is not directly observed by the CRA (e.g., hidden income), payment gaps can be calculated based on CRA’s accounting records – taxfilers have either paid or have not paid their taxes owing. Since payment gaps presented in this report account for reassessments (e.g., audits and appeals) and collection efforts, it cannot be directly added to other tax gap estimates unless they too account for reassessments. Therefore, the payment gap results are presented separately from previous estimates. The payment gap results will be added to the previously published tax gap estimates in a future report.
Evolution of the Total Payment Gap for Tax Years 2008, 2011, 2014Footnote 3
|Year After||Tax Year 2008||Tax Year 2011||Tax Year 2014|
|Payment Gap Component||Payment Gap after One Year ($billions)||Payment Gap as of 2020 ($billions)||% Decline|
|Excise Duties and Taxes||$ - Footnote 5||$ - Footnote 5||- Footnote 5|
|Total Payment Gap||$5.29||$2.19||-59%|
What is the tax gap?
Broadly defined, the tax gap is the difference between the taxes that would be paid if all obligations were fully met in all instances, and taxes that are actually paid and collected.
Although it is sometimes seen as a measure of tax evasion or fraud, the tax gap is the result of both intentional and unintentional actions. For instance, non-compliance can be due to:
- deliberate choices (such as hiding income or over-claiming deductions/credits)
- ignorance of filing, reporting, and payment obligations
- inability to comply (such as when a taxpayer declares bankruptcy and cannot pay their tax debt)
In addition, changes to tax rules and economic events can affect the tax gap. For example, changes to a tax form can improve reporting compliance, while increased bankruptcies in a recession can make payment compliance worse. Therefore, tax gap levels are not fully under the control of the government. This also means that not every dollar of the tax gap can be collected (i.e. the tax gap will never be zero). However, the CRA’s compliance and outreach activities can help to reduce the federal tax gap in Canada. Helping to identify ways to increase the rate of voluntary compliance is an important goal of tax administration.
Estimating the tax gap
Tax gap estimation is complex and requires nuanced analysis. It is generally difficult to measure the tax gap directly since it involves income, assets, and economic activities that are deliberately hidden, or errors that can be difficult to detect.
Tax gap estimation typically requires using one of two approaches to estimate tax loss.
- Top-down approach: Often used when looking at indirect domestic taxes like GST/HST, a top-down approach uses aggregate data (usually national accounts data or other data that is independent from tax data) to estimate the tax base. This base is then used to calculate a theoretical value of tax that should be paid and collected, by applying an effective tax rate. The actual amount of tax paid and collected is then subtracted from the theoretical value to estimate the tax gap.
- Bottom-up approach: Often used for direct taxes like income tax, a bottom-up approach uses administrative tax data to estimate a tax gap. In general, non-compliance is measured using a statistically representative sample of taxpayers that have been audited, which is then extrapolated to the entire taxpayer population to produce a tax gap estimate. This estimate of non-compliance is often based on data from audits or surveys.
According to a survey conducted by the Organisation for Economic Co-operation and Development in 2017, 15 countries indicated that they published tax gap estimates related to at least one type of tax (typically the value-added tax), with only a dozen countries publishing estimates for all major types of tax. These tax gap estimates generally included:
- value-added taxes (such as the GST/HST)
- personal income taxes
- corporate income taxes
- excise taxes (such as for tobacco, alcohol, and luxury cars)
The CRA, in collaboration with the Canadian Tax Foundation, held a conference with experts and international government officials in June 2017 to share perspectives and best practices on tax gap estimation.
Canada and the tax gap
To date, the CRA has released seven reports on the tax gap.
Released in June 2016, Tax Gap in Canada: A Conceptual Study was the CRA’s first step towards understanding the concept of tax gap and what it can and cannot tell Canadians and the CRA about compliance with Canada’s tax system. The study provided a definition of the tax gap, discussed the challenges with tax gap estimation, and examined how tax gap estimates can be used in administering taxes. The study also provided an overview of the work done by some of the other countries that use tax gap estimation.
Also released in June 2016, Estimating and Analyzing the Tax Gap: Related to the Goods and Services/Harmonized Sales Tax (GST/HST) provided an estimate of Canada’s GST/HST gap. The GST/HST gap was estimated to be $4.9 billion in 2014 with the GST gap (i.e., the federal component) accounting for about $2.9 billion. The analysis was conducted for a 15-year period to account for changes in Canadian tax policy, including the introduction of the HST in several provinces over that time period. The GST/HST gap was estimated to be an average of 5.6% of potential GST/HST revenues over a 15-year period (2000 to 2014). In addition to providing the estimate of the GST/HST gap, which was produced by the Department of Finance, the report also presents the methodology and situates the estimate among those of other tax jurisdictions.
The CRA released its third report in June 2017, Tax Assured and Tax Gap for the Federal Personal Income Tax System, an estimation of the domestic personal income tax gap and a measure of income tax compliance in Canada using tax-assured indicators. The report found that extensive third-party information reporting, in combination with other features of the tax system, contribute to a tax base that is largely assured or at low risk of non-compliance with minimal direct CRA intervention – 86% of income assessed was considered as assured in 2014.
The report also provided two tax gap estimates for the 2014 tax year:
- assessed personal income taxes that are not collected by the CRA were estimated to be about $2.2 billion (includes both domestic and international income sources)
- the tax loss related to unreported income earned in key underground economy activities was about $6.5 billion
Together these tax gaps amount to $8.7 billion or 6.4% of federal personal income tax revenues for the 2014 tax year before considering any audit results.
The CRA’s fourth report, International Tax Gap and Compliance Results for the Federal Personal Income Tax System, examined the international component of the tax gap with a focus on individuals and builds on the study on the domestic personal income tax gap. The report provided an in-depth analysis of foreign reporting obligations, completed international risk-based audits, and an estimate of Canada’s offshore investment income tax gap. For the 2014 tax year, the offshore investment income tax gap was estimated to be between $0.8 and $3.0 billion before accounting for audit results or 0.6% and 2.2% of the personal income tax revenues.
The CRA released its fifth report in June 2019, Tax Gap and Compliance Results for the Federal Corporate Income Tax System, which examined the federal corporate income tax gap related to reporting non-compliance, where corporations fail to provide complete and/or accurate information on their income, deductions and/or credits. It also highlights the CRA’s key compliance programs and initiatives related to corporate taxpayers. The report provided tax gap estimates for the 2014 tax year:
- The federal tax gap for incorporated small and medium enterprises was between $2.7 billion and $3.5 billion before considering any audit results. Based on a previous year’s audit results, audits are estimated to reduce the tax gap for small and medium enterprises by between 31% and 40%, resulting in a tax gap of between $1.6 billion and $2.4 billion in 2014. This tax gap represents between 4% and 6% of overall federal corporate income tax revenue in 2014.
- The federal tax gap for large corporations is estimated to be between $6.7 billion and $7.9 billion before considering any audit results. Based on a previous year’s audit results, audits are expected to reduce the large corporate tax gap by between 64% and 75%, resulting in a tax gap between $1.7 billion and $2.9 billion. This tax gap represents between 4% and 7% of overall federal corporate income tax revenue in 2014.
- Together, the federal corporate income tax gap for tax year 2014 is estimated to be between $9.4 billion and $11.4 billion before considering any audit results. Assuming audit results from tax year 2014 are similar to a prior year, audits are expected to reduce the tax gap by $6.1 billion or by 55% to 66%. After considering audit results, the tax gap for tax year 2014 is estimated to be between $3.3 billion and $5.3 billion or between 8% and 13% of overall federal corporate income tax revenue.
Released in December 2020, the Tax Gap for Federal Excise Duty on Cigarettes examined the tax gap related to illegal production/smuggling of cigarettes. It also highlights the CRA’s compliance efforts in the tobacco industry. The report provided tax gap estimates for the 2014 tax year:
- Based on the first method called gap analysis, the federal excise duty gap for cigarettes was estimated to be about $483 million for tax year 2014.
- An alternative approach, an econometric model, was developed to estimate the gap. It estimated the federal excise duty gap for cigarettes to be about $490 million for tax year 2014.
- Since the two estimates are relatively close in dollar value, an average was used (each was given equal weight). The federal cigarette duty gap is estimated to be around $486 million for tax year 2014. This represents 16% of cigarette excise duty revenue, or about 4% of overall federal excise duties, taxes and other specific levies revenue.
Combining the federal cigarette excise duty gap with other tax gap components previously published by the CRA, Canada’s federal tax gap for tax year 2014 is estimated to be between $20.1 billion and $24.3 billion or between 9.2% and 11.2% of corresponding revenues – before considering the impact of audits. This estimate provides a picture of the overall federal tax gap (excluding the payment gap) for Canada’s major revenue-generating taxes before any CRA enforcement activities such as audits.
The CRA’s seventh report, the Payment Tax Gap and Collection Efforts, was also published in December 2020. This report examines the tax gap resulting from payment non-compliance – when assessed taxes are not fully paid by taxfilers for a particular taxation year. The payment gaps for tax years 2008 to 2014 were calculated for four types of taxfilers – individuals, corporations, Goods and Services Tax/Harmonized Sales Tax (GST/HST) registrants, and excise tax and duty licensees/registrants. It also highlights the CRA’s key compliance programs and initiatives related to taxfilers. The report provided tax gap estimates for the 2014 tax year:
- The payment gap is the sum of assessed taxes that are not fully paid by the payment deadline for a particular tax year. The total payment gap for each tax year was calculated by aggregating the payment gap amounts for all four types of taxfilers.
- The total payment gap for tax year 2014 amounted to $5.29 billion after one year (2015), before declining by 59% to $2.19 billion as of 2020.
- The payment gap decreased at a faster rate for individuals (-76%) compared to corporations (-38%) and GST/HST registrants (-30%).
- The payment gap amounts presented in this report include outstanding debt and write-offs (uncollectable tax debt), but exclude interest and penalties (regardless of whether they are written-off or not).
- The Canada Revenue Agency (CRA) makes every effort to work with taxpayers to settle outstanding debts. On occasion, once the CRA has exhausted collection avenues and it is determined that a taxpayer is incapable of repaying their debt, the CRA will write off a debt.
- In 2019-2020, the CRA resolved just over $65 billion in outstanding tax debt, of which around 5% was written-off. The percent written-off is fairly consistent each year.
- Writing off a debt, in most cases, does not release the taxpayer from their obligation to pay off the debt and write-off amounts can be reinstated. It means legal actions will not be undertaken to collect the debt unless the taxpayer’s financial situation improves.
- Unpaid tax debts represent a small portion of the total receivables. The vast majority of accounts receivable will be collected over time.
There are key features of the payment tax gap that makes it difficult to compare with CRA’s previous tax gap estimates. Therefore, the payment gap cannot be directly added to previous tax gap estimates without special considerations. This will be explored in a future overall tax gap report.
The CRA’s tax gap estimation program informs the CRA and the public about tax compliance and non-compliance. The program also helps to deliver on the Government’s commitment to ensure a tax system that is fair and responsive to all Canadians. This supports an economy that works for all Canadians.
In 2021, an overall tax gap report will bring together all the components examined to date and update the tax gap figures up to tax year 2017. This overall tax gap report will also provide additional information on the impact of CRA audits in reducing the overall tax gap. Canada’s tax gap estimates will be regularly updated to ensure they remain relevant. Through an ongoing effort to understand different components of Canada’s tax gap, the CRA will continue to preserve the integrity of the tax system and protect Canada’s revenue base that supports programs and benefits that improve the quality of life of all Canadians.
Report a problem or mistake on this page
- Date modified: