Why we’re collecting less income tax – the rise of the black economy

Why has the income tax take not risen as the UK economy has begun to rise?

A good many explanations have been put forward for this. The most obvious of all is that the continuous rise in the personal allowance means that, all other things being equal, the average person in work pays less tax than they did five years ago. See my interview with Nick Clegg where we discuss this, among rather a lot of other things.

Why else would the government be boasting that eight million families are £1,330 better off as a result of their policies? .

But as I have written here before – and as I brought up in the same interview with Clegg that I mention above – it is also about the black economy, which is many, many times larger than the state likes to think. It has been growing quickly, thanks to both the rise of internet opportunities and the post-crisis fall in some real wages.

An accountant told me this week, when I was nitpicking over my own tax return, that he reckons some 30% of the personal income tax due goes uncollected. HMRC appears to be slowly beginning to come to the beginnings of a similar conclusion.

It isn’t easy to figure out just how big the ‘informal economy’ is: one HMRC officer told the FT that it is “like looking for the absence of a cat in a dark room” (the same joke Norman Lamont uses about economic forecasting…).

But economists at Morgan Stanley looked at the amount of cash circulating in the economy last year and figured out that since 2007 the grey economy has increased in size by the equivalent of about 3% of GDP.

Black economy - amount of cash circulating as % of GDP

HMRC has now looked at the number of people who have taken on second jobs since 2007. There has been a 40% increase in the number of people who now declare a second self employed role alongside their main salaried job. That’s a number that rises dramatically if you take a stab at guessing the number of moonlighters around (those who don’t declare second incomes.)

HMRC reckons the tax not collected from this group rose 10% in 2012/3 alone, and now comes to around £2.1bn. Their guesstimate of the amount not collected from those only moonlighting – ie with no official job – comes to about £1.3bn. That makes a total of £3.4bn.

That’s less than 3% of the total income tax take, and a mere 10% of what the working accountant I mention above suggests makes up the missed take. But it makes an interesting start.