Making tax digital - the impact on public finances

23 August 2016

Andrew Hubbard

In last week’s piece I looked at the possible savings to businesses from HMRC’s digital strategy and suggested that looking at things purely from a pound note perspective might not be the best measure of benefit. This week I want to look at the impact on the public finances from the move to digital.

There are two quite different areas of saving. One is the cost to HMRC in running the tax system. Clearly there are savings to be made here and I don’t want to dwell on these. The other area is the impact on tax receipts. That does interest me.

It is not immediately obvious that a change in the way that the tax system is administered should have any effect on the amount of tax which is collected. After all a tax return is a tax return, whether it is engraved on tablets of stone, handwritten on parchment or digitally reduced to a series of ones and zeros. Yet the consultation suggests that there will be a £945m increase in tax revenues as a direct result of digitisation in the period up to full implementation in 2020-21, and an annual increase of £625m thereafter. Where do these figures come from?

HMRC believes that if businesses are forced to keep records digitally and report quarterly they are more like to keep accurate records and take more care in dealing with their tax affairs. I suspect that there is some truth in this: remembering what you did a year ago is much easier if you kept a note of it at the time. But it works both ways. There will be plenty of cases where somebody fails to claim tax relief on something allowable because they didn’t have information to hand when they completed their return.

I hope, as nothing is said about this, that the £625m is a net figure taking into account errors in the taxpayer’s favour. But what about that figure itself? HMRC say that it is derived from the tax gap estimate for errors and failure to take reasonable care. The last published figures show that these two categories contributed £6.5bn to the tax gap. Broadly half of that - £3.25bn - is attributable to SMEs, who are most likely to be affected by these changes. That means that nearly 20 per cent of that gap is estimated to be closed by improvements in record-keeping arising out of the digital strategy. That doesn’t seem to me to be in itself an unreasonable percentage, but of course it depends on how reliable the tax gap estimate itself is – something we have commented on before in this bulletin.

Let’s look at it another way. There are 5.4 million small businesses in the UK. If we simply divide the estimated tax savings by the number of business we get a figure of £115 per business. That might not seem too high, but remember that this is the tax effect. Assuming that most businesses pay tax at 20 per cent (a crude generalisation but one which will suffice for this purpose), that means that the average error per business is something like £575 each year. That seems quite high to me, particularly when you recall that the results of HMRC’s business records check initiative was that businesses were keeping records to a higher standard than was originally suspected.

We are back where we were last week: drawing conclusions from relatively small amounts over a very large population is extremely difficult. Averages can be very misleading. I think that the move to a digital environment will improve record-keeping and on balance will operate in HMRC’s favour. Whether it will produce anything like the additional revenue predicted in the HMRC document is open to question. I suspect that we will never know. There are so many factors which impact on tax receipts that I doubt it will ever possible to identify what is actually attributable to the digital environment.

This is not of course a reason to abandon the digital strategy. As we discussed last week, it will, once all the lumps and bumps have been ironed out, give businesses more control of their tax affairs, and this must be a good thing. Today’s announcement that individuals will be able to obtain tax refunds via their personal tax account is a good example of the improvements which can be made. But let’s not justify policy making purely on statistics.

For more information please get in touch with Andrew Hubbard, or your usual RSM contact.