Since You Asked

Cash in hand is worth £35bn in the tax bush

‘Getting a discount with your plumber by paying cash in hand is something that is a big cost to the Revenue and means others have to pay more in tax. I think it is morally wrong.’

David Gauke, Treasury minister, July 24

I feel bad now. I always pay my cleaner in cash.

Don’t feel too bad. I always pay my cleaner in cash, too, and for that matter I use cash to buy coffee. There are legitimate reasons for paying with cash, as just about every other government minister has squeaked over the past few days.

But if a plumber or an electrician offers a heavy discount in exchange for cash payment, surely you have to admit that something is fishy?

It might still be legitimate – prompt payment can save a business and cheques can bounce. But of course Mr Gauke has a point: if somebody wanted to evade tax they’d find it much easier with cash in hand.

And if I agree to pay cash in hand, am I helping the plumber to evade tax?

Economically speaking, the plumber is helping you to evade tax. Lawyers and accountants look at the legal responsibility for paying tax and that lies with the plumber. But economists look at something called “tax incidence”, which is who ultimately bears the cost of the tax. A tax on plumbing might well increase the post tax cost of plumbing far more than it lowers the post-tax wages of plumbers.

Why do you say that?

Let’s make a couple of assumptions. Assume that most plumbing work is not price sensitive: if the lavatory is leaking, you pay to have it fixed, whatever the cost; at the same time, nobody has cheap plumbing work done for the joy of a bargain. Assume also that the supply of plumbing services is quite elastic; if plumbing becomes more profitable, more plumbers will arrive from Poland and prices will fall; if plumbing becomes less profitable the Polish plumbers will ply their trade elsewhere.

You and your assumptions will get you into trouble one day, but go on.

If these assumptions are broadly true then any tax on plumbing would ultimately be paid by consumers, not by plumbers. Tax evasion would help consumers themselves, not the plumbers.

Interesting. But isn’t this a fuss about nothing? Isn’t the really big-deal tax evasion by zillionaires and
multinationals?

It’s certainly not a fuss about nothing. We could look at estimates from Revenue & Customs about how much tax they think is going missing. They call it the “tax gap”, and it represents the difference between how much tax they think they should be receiving in accordance with both the letter and the spirit of the law, and how much is being paid. That gap is partly due to error, partly due to tax evasion (violating the letter of the law), partly due to tax avoidance (violating the spirit of the law) and partly due to outright fraud.

How big is the tax gap?

We’re not sure. After all, not many people make explicit declarations of how much tax they are evading. But we have estimates and in 2009-10, the most recent year available, the tax gap was about £35bn.

Is that a lot?

It is big enough to worry about: 7 per cent of total revenue, give or take, and more than £500 for every man, woman and child in the country.

How much of that is down to cash-in-hand payments?

Potentially quite a bit. About half of the tax gap can be blamed on small and medium-sized companies, a category that would include most cleaners and plumbers, as well as companies with 100 employees or more. A quarter is attributed to large companies and their battalions of tax lawyers; 17 per cent to outright criminal scams; 11 per cent to individuals. The problem goes beyond any one particular category of scapegoats. And, alas, I am unable to find any estimates that break down culpability by income level.

So tax evasion is really a blue-collar crime, then?

No, I think that is wildly over-interpreting. But it is certainly not the exclusive preserve of the Monaco set. One important thing is missing from the HMRC definition of “tax gap”, however. It’s an estimate of how much tax is demanded yet not paid. But remember that how much tax is demanded is itself a function of opportunities to evade tax. If multinational companies are footloose, for instance, governments may offer low rates and generous tax breaks. The tax gap would then be small on paper but large relative to the taxes the Treasury might fantasise about levying.

Also published at ft.com.

28th of July, 2012Since You Asked • Comments off