How Can Tax Gap Inform Tax Policy and Administration? A Case Study of Australia’s Individuals Income Tax

Abstract

Over the last decade or so, a relatively small but growing number of national revenue agencies have sought to better understand the health of their tax system by turning their attention to the concept of the ‘tax gap’— the difference between the estimated amount of tax legally payable for each tax administered and what is actually collected in practice. This interest has brought a focus to better understanding tax gap estimation methods (in particular, their strengths and limitations), the introduction of comprehensive tax gap research programs, and the public dissemination of tax gap findings to increase community awareness and signal the fact the revenue agency is serious about the tax gap as a long-term performance measure. And as these agencies often have administrative responsibility for more than just taxes (e.g. student loan repayments and superannuation contributions), these tax gap estimates can have implications beyond just taxes. In the case of Australia’s individuals income tax, this means that related tax gap estimates also have implications for government agencies administering income-related transfers (e.g. pensions and unemployment benefits) and service entitlements (e.g. health care cards).

This paper builds on recent tax gap research findings published by the Australian Taxation Office (ATO) and examines what they mean for the main types of individuals income tax non-compliance, the main perpetrators, the behaviours underlying this non-compliance, and possible policy and administrative responses. The analysis is made by allocating the ATO’s individuals income tax gap estimates for 2015-16 to its 2% individuals sample file of taxpayers in 2016-17 and reviewing the results by sources of tax gap and how they differ across various socio-economic and demographic groupings. The paper also examines what these results might mean for the repayment of income-contingent Study and Training Support Loans (STSL) and for the payment of means-tested government transfers.

Finally, the paper presents a menu of potential reforms to address key weaknesses in individuals’ income tax policy design and administration that are resulting in considerable revenue leakage.

Keywords: Taxation, tax administration, tax gap, tax reform, personal income tax

JEL Classification: H24 H25