Measuring Canada’s Tax Gap

Tax evasion is a serious policy issue faced in every country that imposes taxes. Most countries, including Canada, throw a lot of resources at trying to curb tax evasion, but few countries actually throw money at producing data and statistics regarding the amount and type of tax evasion occurring. This is unfortunate because without this information, it is not clear whether the marginal benefit of cracking down on various types of evasion is worth the marginal cost. That is, can more be recovered than it costs to collect.

As a result, it is important to have detailed information about the tax gap. The tax gap is the gap between the taxes that should be paid and the taxes that are actually paid. As most Canadians are aware, Canada has no official measure of the tax gap. There have been calls by many that this should change, including by myself, but also by my MP, NDP’s own Murray Rankin.

Are there countries that measure the tax gap? Yup, notably the U.K. and the U.S., which both produce regular detailed estimates of the tax gap.

The U.K. estimates the tax gap to be £35 billion or 7% of total tax liabilities. Nearly half of the tax gap comes from the activities of small and medium sized businesses. The U.K. also purports that the tax gap has shrunk in the last six years, largely due to greater enforcement in the areas of excise taxes and their VAT.

In the U.S., the IRS estimates the gross tax gap to amount to 17% of total taxes paid voluntarily (the equivalent of US$450 billion in 2006) and the noncompliance rate to be a whopping 16.9%. Using the usual estimate that Canada is roughly 10% of the size of the U.S., this would put our tax gap at approximately $45 billion (more than StatsCan’s ‘estimate’ of the whole Canadian underground economy!). The U.S. tax gap is comprised of $28 billion lost to nonfilers, $46 billion lost to those who underpay their liabilities, $376 billion is lost to those who underreport. In contrast to the U.K., the IRS estimates that most of the tax gap accrues to individuals, amounting to 67% of the total tax gap. The IRS notes that is was able to collect $65 billion of the tax gap for a recovery rate of a dismal 14.4%.

The EU also produces estimates of the tax gap. For all EU countries, the tax gap is estimated to be approximately €860 billion and tax avoidance amounts to an additional €150 billion. This means that EU countries miss out on nearly €trillion in unpaid taxes. Of this, the total tax gap for the VAT alone is nearly €200 billion.

I recently wrote a blurb for the Globe and Mail Report on Businesses (nestled unkindly behind their pay wall) that concluded that “Given the potential magnitude of lost tax revenues in Canada, it is essential we have greater data and information about the Canadian tax gap, similar to that which exists in the US and UK.” If the government is truly serious about tax evasion and cracking down on tax loopholes, this is essential data to have. I also think it is important for CRA to be more open about what proportion of the tax gap is recovered through its enforcement activities. I hope they do a better job than the IRS, but somehow I doubt it.