Tax gap: A brief overview

CRA’s tax gap reports

In 2022, the Canada Revenue Agency (CRA) published Canada’s first overall tax gap report which brings together all previously published tax gap components with updated estimates and key findings up to tax year 2018.

• Overall federal tax gap report: Estimates and key findings for non-compliance, tax years 2014-2018

In addition to this overall tax gap report, the CRA published a separate methodological annex which contains more technical details related to the methods used to estimate the different components of the federal tax gap. The purpose of this annex is to bring together methodologies for all tax gap components in a single document and present key methodological updates.

• Tax gap methodological annex

Since 2016, the CRA has published reports on various components of the federal tax gap, including estimates and their underlying methodologies.

• Previous tax gap reports 

What is the tax gap

Broadly defined, the tax gap is the difference between the taxes that would be paid if all obligations were fully met in all instances, and taxes that are actually paid and collected.

Although it is sometimes seen as a measure of tax evasion or fraud, the tax gap is the result of both intentional and unintentional actions. For instance, non-compliance can be due to:

• deliberate choices (such as hiding income or over-claiming deductions/credits)
• mistakes
• ignorance of filing, reporting, and payment obligations
• inability to comply (such as when a taxpayer declares bankruptcy and cannot pay their tax debt)

In addition, changes to tax rules and economic events can affect the tax gap. For example, changes to a tax form can improve reporting compliance, while increased bankruptcies in a recession can make payment compliance worse. Therefore, tax gap levels are not fully under the control of the government. This also means that not every dollar of the tax gap can be collected (in other words, the tax gap is unlikely to be zero). However, the CRA’s compliance and outreach activities can help to reduce the federal tax gap in Canada. Identifying ways to increase the rate of voluntary compliance is an important goal of tax administration.

Why measure the tax gap

In April 2016, the Government of Canada committed to estimating the federal tax gap and a dedicated unit was established at the CRA to examine and publish a series of reports analyzing different components of the tax gap.

The publication of tax gap estimates and methods provides information to the Government of Canada and the public on tax non-compliance and helps to deliver on the Government’s commitment to transparency. In addition, a more insightful understanding of the tax gap can help the CRA better target its compliance and collection activities.

Understanding how and why taxpayers are non-compliant is critical to help preserve the integrity of the tax system and to protect Canada’s revenue base, which supports programs and benefits that improve the quality of life for all Canadians.

Estimating the tax gap

Tax gap estimation is complex and requires nuanced analysis. It is generally difficult to measure the tax gap directly since it involves income, assets, and economic activities that are deliberately hidden, or errors that can be difficult to detect.

Tax gap estimation typically requires using one of two approaches to estimate tax loss.

• Top-down approach: Often used when looking at indirect domestic taxes like GST/HST, a top-down approach uses aggregate data (usually national accounts data or other data that is independent from tax data) to estimate the tax base. This base is then used to calculate a theoretical value of tax that should be paid and collected, by applying an effective tax rate. The actual amount of tax paid and collected is then subtracted from the theoretical value to estimate the tax gap.
• Bottom-up approach: Often used for direct taxes like income tax, a bottom-up approach uses administrative tax data to estimate a tax gap. In general, non-compliance is measured using a statistically representative sample of taxpayers that have been audited, which is then extrapolated to the entire taxpayer population to produce a tax gap estimate. This estimate of non-compliance is often based on data from audits or surveys.

The tax gap can be presented before and after accounting for compliance and collection results: 

• Gross tax gap – Tax gap estimate before accounting for compliance and collection actions
• Net tax gap – Tax gap estimate after subtracting compliance and collection results from the gross tax gap

Canada’s tax gap estimates

Building on the foundation of previously published tax gap studies, the latest report examined Canada’s overall federal tax gap for the 2014 to 2018 tax years. Tax year 2018 was selected as the latest year of analysis in order to examine the most recent tax gap data, including compliance and collection results which can take several years to complete. The CRA’s approach balances timeliness with the overall quality of tax gap estimates and this approach is aligned with the CRA’s international partners. 

During fiscal years 2014-15 to 2018-19, Canada’s federal tax revenue increased from $236.6 billion to $271.8 billion. As Canada’s federal tax revenue increased, so did the potential federal tax gap. However, the CRA is holding the federal net tax gap stable at approximately 9% of federal tax revenues.

This was possible because the CRA compliance and collection activities reduced the gross tax gap, on average, by 39% to 45% during tax years 2014 to 2018. These activities had a particularly strong impact on the corporation income tax (CIT) gap, reducing the gross tax gap by an average of 48% to 59% during tax years 2014 to 2018.

With additional investments from recent budgets, the CRA has increased its ability to identify and target tax non-compliance. Therefore, the CRA expects the federal tax gap to decrease over time relative to what it would be without these investments.

The graph below shows Canada’s overall federal tax gap for the 2014 to 2018 tax years, using upper-bound estimates. The increasing impact of CRA’s compliance and collection activities have played a key role in keeping the tax gap stable as a percentage of federal tax revenues during a growing economy.

Total net tax gap for tax years 2014 to 2018, upper-bound estimates*

*All amounts are in constant 2018 dollars. Totals may not add due to rounding. Does not include non-residents.

* All amounts are in constant 2018 dollars. Totals may not add due to rounding. Does not include non-residents.

Going forward

The CRA’s tax gap estimation program informs the CRA and the public about tax compliance and non-compliance. The program also helps deliver on the Government’s commitment to ensure a tax system that is fair and responsive to all Canadians. 

Although the CRA only began estimating the tax gap since 2016, Canada has become one of the leading countries that both estimate and publish their tax gaps and we are playing an important role in providing methodological advice to the international community. The CRA will continue to study Canada’s tax gaps in consultation with experts and stakeholders to better understand non-compliance and maintain the integrity of the tax system.