An NAO review has identified 362 ‘tax expenditures’, classified as tax interventions to support particular groups or sectors, and to incentivise behaviour. 

Examples include tax credits for companies’ research and development (R&D) costs and income tax relief on pension contributions.

Between 2014-15 and 2018-19, the total cost of tax expenditures increased by 5% in real terms, from £147bn to the current forecast of £155bn.

The audit watchdog found that HMRC had only costed a third (111) of these reliefs. HMRC plans to estimate the costs for more tax expenditures between 2020 and 2022, prioritising those it considers higher risk.

There were 23 tax reliefs each costing more than £1bn and accounting for 92% of the total forecast cost in 2018-19.

The largest tax breaks were the reliefs on pension contributions, zero rated VAT on some food and also that on new properties, as well as relief from capital gains tax CGT) on the sale of primary residences, ie, main homes.

Both the NAO and the Public Accounts Committee have repeatedly raised concerns about the departments’ management of tax reliefs, while in July 2019, the Office for Budget Responsibility (OBR) identified the costs of tax reliefs as one of four new fiscal risks to the public finances.

The OBR was concerned that the government did not know the full cost of tax reliefs and that they lacked transparency and scrutiny which simply added complexity to the tax system.

One of the tax reliefs that the government is understood to be reviewing is entrepreneurs' relief which costs more than £2bn a year. Only 8% of people claiming entrepreneurs’ relief in the previous five years said it had influenced their investment decision making. 

Evaluation failings

The NAO review considered a range of reliefs, including zero rating of VAT on the construction and sale of new dwellings; relief from inheritance tax on agricultural property; relief on employer national insurance contributions (NICs) for employees under 21 and apprentices under 25; the enterprise investment scheme (EIS), and a range of R&D reliefs including patent box and film tax relief.

There have been only 15 evaluations of different tax breaks since 2015, representing just 7% (£11bn) of the aggregate forecast cost of tax expenditures in 2018-19.

HMRC has evaluated only five of 23 tax expenditures costing more than £1bn, and less than half of the large tax expenditures that have grown the fastest.

The Treasury has informally assessed whether 63 tax reliefs offered value for money as part of its policy-making process.

The NAO was critical of the Treasury’s failure to consider the impact of specific tax breaks when they were first introduced, saying it did not find any instances since 2013 where government had set out plans for their evaluation at design stage, or triggers for evaluation if costs or benefits differed significantly from their forecasts.

The watchdog compared forecast and actual costs for 10 tax expenditures and found that for five tax expenditures introduced since 2013, including three of the four largest, data indicated costs were generally in line with original forecasts.

However, for the R&D expenditure credit, and four smaller tax expenditures introduced since 2013, data indicated costs exceeded forecasts by 50% or more.

It was more difficult to compare forecasts and actual costs for tax expenditures introduced before 2013. However, the costs of three of the case study tax expenditures had grown from around £1bn in 2008-09 to around £5bn in 2017-18, much faster than the trends indicated in published forecasts.

For R&D reliefs, HMRC compared the total R&D companies had claimed in tax returns for UK and overseas activity, with national statistics on total UK (only) R&D activity.

This comparison revealed that the R&D activity companies had claimed was rising more quickly, and in 2016-17 exceeded all UK R&D activity by 43%.

Further HMRC research in 2017 and 2018 identified high levels of abuse of R&D claims, particularly by companies with a limited UK presence, which has led to more training and focus on this area.

Overall, the NAO found HMRC’s evaluations of tax expenditures suggested that their effectiveness varies widely.

Evaluations published since 2015 by HMRC have assessed the impact of 13 of the 15 tax expenditures covered. Seven of these costing £3.6bn in 2018-19 had a positive impact on behaviour, but one costing £1.4bn had had a mixed impact.

The NAO found that while HMRC has developed internal, informal processes for assessing the value for money of tax expenditures, there is no formal documentation specifying explicitly the departments’ accountabilities for the value for money of tax expenditures.

It said HMRC’s statistical bulletin has improved but still contains very limited information on the benefits achieved by tax expenditures, only limited commentary on their cost trends, and although HMRC included estimates for the number of claimants for the first time in January 2019, there is no trend data on the numbers of businesses using the targeted tax breaks.

The bulletin does not explain how costs and benefits differ from the original published forecasts. Other countries have more comprehensive evaluation and reporting despite most having comparatively lower levels of tax expenditures.

The report concluded: ‘Both departments need to make substantial progress and ensure sufficient coverage and rigour in the work they undertake on this matter.

‘On their own these improvements will not be sufficient to address value-for-money concerns unless the departments formally establish their accountabilities for tax expenditures and enable greater transparency.’

The management of tax expenditures issued February 2020