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 five 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)
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.
|Tax Gap Component||Federal Tax Gap Estimate Before Audit||% of Corresponding RevenuesFootnote 2|
|Goods and Services Tax
|Domestic Personal Income Tax
|International Personal Income Tax||$0.8-$3.0 billion
|Corporate Income Tax
($3.3-$5.3 billion after audit results)
(8%-13% after audit results)
|Total Tax Gap to Date
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 five 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.
Combining the corporate income tax gap with other tax gap components previously published by the CRA, Canada’s federal tax gap before considering the impact of audit for tax year 2014 is estimated to be between $21.8 billion and $26.0 billion or between 10.6% and 12.6% of corresponding revenues. This estimate provides a picture of the overall federal tax gap for Canada’s major revenue-generating taxes before any CRA enforcement activities such as audits.
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.
Moving forward, subsequent tax gap reports will examine topics such as the payment gap, excise tax gap, non-compliance in the claiming of deductions and credits by individuals, and the impact of audits in reducing the overall tax gap. As well, 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.
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