Are two million people making cash-in-hand payments costing the treasury over £2 billion?

"More than two million people make cash-in-hand payments costing the Treasury an estimated £2?billion"

Daily Telegraph, 24 July 2012

As part of the national belt-tightening, HM Revenue & Customs (HMRC) has launched a string of campaigns and tactics in an attempt to tackle the "hidden economy", or "undeclared economic activity".

One of the most publicised elements of the so-called 'hidden economy' has been the media targeting of high-profile, individual tax avoiders. However this week Treasury Minister David Gauke hit out at a somewhat different target.

His moral furore concerns employers or customers who pay a worker or a trader for their services cash-in-hand, which could include homeowners paying self-employed house maintenance services (plumbers, builders, decorators and so on).

Although it is illegal for the self-employed to keep their income hidden, Mr Gauke also blames the cash payments made by two million ordinary people as an implicit collaboration with the illegal activity. One consequence of this is a hole in the treasury's pocket approximately £2 billion wide which, Mr Gauke claims, makes such payments morally wrong.

Stepping away from making any moral judgement, are the figures themselves correct?

Analysis

The statistics can be traced to two reports; the National Audit Office's 2008 publication; "Tackling the Hidden Economy", and the review of this report by the Committee of Public Accounts, released in the same year.

Focusing on the report by the Committee of Public Accounts (CPA), it quite clearly states that the amount of tax lost through the hidden economy could total "over £2 billion a year and involve around 2 million people".

The estimation was calculated based on three types of tax loss:

1) Businesses which should be registered to pay tax such as VAT, but are not - for example, a trader who directly exchanges items for cash, either through the internet or in their home.

2) 'Ghosts', or people who pay no tax on their income.

3) 'Moonlighters', or people who pay tax on some of their earnings, but not on others.

Builders or plumbers who are paid via cash payments could be examples of ghosts and moonlighters.

It is a combination of all three types of tax losses which make up the estimated figures, so it's important to understand the Telegraph's claim doesn't just refer to cash-in hand payments to builders or plumbers, but also includes businesses failing to register for VAT.

But how did HMRC arrive at its £2 billion figure? 

VAT losses to businesses (£400-£500 million)

The figures for VAT losses by businesses were compiled by the National Audit Office (NAO) in 2002, which estimated that the Treasury lost between £400m and £500m in VAT from between 125,000 and 185,000 businesses which were not registered in 2001-2002. 

Full Fact hasn't been able to find a copy of the original estimates, however several reports since have alluded to this figure, including research by the European Commission in 2009.

We naturally have to treat this figure with caution since it's now a decade old, and the NAO themselves insist the estimates even then weren't robust. For now it seems HMRC are content to still use this figure until better data becomes available.

Ghosts and Moonlighters (£1.5 billion)

HMRC break down the remaining costs into ghosts and moonlighters, who collectively total £1.5 billion of the estimate (three quarters of the total).

These date back to a report by HMRC in 2005 "Estimation of tax gap for direct taxes" which calculated there were around 520,000 ghosts and 1,500,000 moonlighters in the UK.

Of these, ghosts accounted for a tax gap of anywhere between £0.5 and £3.1 billion, while moonlighters accounted for between £1 and £3 billion. The 2008 estimate appears to have taken the lower estimates of each.

However looking at the methods by which these were calculated, it's even more difficult to treat the overall figure with much credibility.

Finding Ghosts

On estimating ghosts, HMRC concedes:

"Ghosts are not accurately recorded by any government agency or survey. Any estimate as to their number or the consequential loss of duty is speculative. Nevertheless it is useful to think about the potential tax loss from this population."

What they do attempt to estimate is based on "expert opinion". As their detail states, this seems to involve doubling the estimated number of fraudulent claimants of Jobseekers Allowance (JSA) in 2005, as well as assuming that five per cent of full time self-employed people as measured by the ONS are ghosts.

In addition, HMRC attempts to account for illegal immigration as contributing towards the ghost total. To do this they used estimated flows of illegal immigration from Migration Watch and assumed that all illegal immigrants receive the minimum wage (admitting that some will be paid less and some paid more - hence assuming all receive it as an average).

It isn't made clear who the 'experts' who were consulted to acheive these estimates are.

In fairness to HMRC, they explicitly caution the use of these figures based on the level of speculation. However merely from what is publicly available Full Fact can't lend any credibility to these estimates.

Finding Moonlighters

HMRC's estimate of moonlighters and their cost seems to have a more solid base. It is based on a survey conducted in Denmark by the Rockwool Foundation Research Unit in 2000, and published in 2003. This used questionnaires aimed at estimating the size of the 'black economy' in Great Britian and other countries.

In summary, using a sample of 1,572 GB respondents, when asked if they have 'carried out black activities in the past year', 7.8 per cent admitted to doing so. HMRC was able to apply this and other results regarding the income of black market participants to the estimated number of British employees. This gave them an estimate of 1.5 million moonlighters accounting for around £1.5 billion in lost revenue.

Again, HMRC do not place a great deal of faith in this estimate:

"We do not think that a survey approach, even an anonmyous survey, will capture "hardcore" moonlighting, for example people paid partly off the books for their main job."

Nevertheless the Public Accounts Committee in its 2008 report still recommended that HMRC work closely with the European Commission to develop better estimates in the future.

So can we rely on the figures?

Since these original estimates were made HMRC has published more recent estimates in its 2011 tax gap report. Here it shows ghosts causing a tax gap of £1.3 billion and moonlighters a gap of £1.8 billion, although the department told Channel 4 factcheck not all of this is down to 'cash-in-hand' transfers anyway.

However as far as the £2 billion cost from two million people is concerned, the estimates themselves are based on speculation and unreliable survey data. Again, the Public Accounts Committee and the National Audit Office are clear that these estimates aren't robust.

Conclusion

Whether or not paying traders or housing maintenance workers cash-in-hand is morally wrong or not, we cannot treat either the £2 million cost or the two million estimate of people with a great deal of credibility.

While the estimates are sourced in HMRC investigations dating back to 2005 - even to a survey conducted in 2000 - these are littered with warnings about the amount of speculation and little evidence the figures are based on.

Given this, it is remiss of any publication not to mention the severe caveats behind these figures, and it should serve as a caution to any publication planning to publish the figures as well.