A National Audit Office report released today focuses on the administrative cost of the tax system. The report finds that HMRC’s costs of administering the tax system increased by 15% (£563 million) between 2019-20 and 2023-24. The report focuses on several areas of expenditure, including increased digitalisation of HMRC services, the administrative burdens on taxpayers and their intermediaries, and trust in HMRC.
This blog focuses on two areas that are of particular interest to TaxWatch’s work, the drive towards digitalisation and modern compliance methods. In both areas, costs are increasing, with mixed results for customer service and compliance. These raise important questions about the focus of HMRC and its future success.
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HMRC spent £785 million running its digital tax systems in 2023-24, marking an 18% increase from just four years ago. When adding the £482 million spent on developing new systems and upgrading legacy ones, the total investment in digital transformation becomes substantial. Digital service costs have risen particularly sharply in key areas: Corporation Tax (up 44%), Income Tax Self Assessment (up 25%), and VAT (up 20%).
The reasons for these increasing costs are complex and interconnected. Making Tax Digital (MTD) program serves as a useful case study. Launched with promises of simplification and efficiency, its results tell a more nuanced story. Among VAT traders, 73% reported no change in productivity after implementation, while only 22% saw improvements. Most tellingly, HMRC’s costs of collecting VAT increased by 15% even after full MTD implementation – a statistic that challenges the conventional wisdom about digital transformation leading to cost savings.
Looking at the report carefully, it presents a mixed picture regarding digitalisation’s impact on efficiency. There are some positive impacts, including:
- Both Making Tax Digital (MTD) and Pay as You Earn (PAYE) Real Time Information (RTI) have increased revenue by reducing the scope for VAT and PAYE errors
- RTI yielded benefits for some taxpayers (though the extent is disputed)
- 72% of businesses felt more confident using digital technologies after implementing MTD in 2019
- Digital channels are handling more transactions (around 60% of customer transactions in 2024)
However, the report suggests that HMRC has not clearly demonstrated reduced running costs resulting from digitalisation:
- HMRC’s costs of running digital tax systems increased by 18% between 2019-20 and 2023-24
- Implementation of digital systems like MTD has imposed significant costs on businesses (estimated around £300 million for VAT traders between 2019-20 and 2023-24)
- Only 22% of businesses reported productivity improvements from MTD for VAT
- Digital service developments have not adequately served tax agents and intermediaries
These findings suggest that while digitalisation may have improved some aspects of tax collection and compliance, it has not yet delivered the expected efficiency savings in terms of reduced administrative costs.
Upstreaming compliance
While the digital transformation continues, HMRC has been changing the emphasis of its approach to tax compliance. This shift represents a fundamental change in philosophy: moving from catching non-compliance after it occurs to preventing it from happening in the first place.
The numbers show this “upstream” strategy gaining significant momentum. In 2019-20, upstream activities accounted for 22% of compliance yield. By 2023-24, this had risen to 33%, representing £14 billion of the total £41.8 billion compliance yield. This isn’t just about detecting non-compliance earlier; it’s about redesigning systems to remove opportunities and incentives for mistakes before they occur.
HMRC believes upstream activities are “generally more cost effective than downstream and can be the only way to tackle some risks”. However, the report identifies significant gaps in HMRC’s understanding, concluding that the evidence base for cost effectiveness of upstream yield is limited. For example, it does not have good data on the impacts of upstream compliance interventions. It also lacks guidance or tools to assist in getting the best balance between upstream and downstream interventions. Better measurement and understanding is needed going forward.
Looking to the future
The government is providing additional resources for HMRC, with 5,000 ‘additional’ compliance staff, targeting an estimated £2.7 billion in incremental annual revenue by 2029-30. However, the NAO report identifies significant challenges that need addressing, including falling compliance yields per caseworker.
On the digital front, HMRC needs to better understand and manage the ongoing costs of its digital estate. The report suggests that the department lacks clear metrics for measuring the success of its digital transformation beyond simple cost metrics. Similarly, while the upstream compliance strategy shows promise, HMRC lacks tools to assess the optimal balance between prevention and enforcement activities.
What’s becoming clear is that digital transformation isn’t a simple path to cost reduction – it’s a complex journey that requires rethinking both processes and metrics of success. As HMRC continues this journey, the true test will be whether these investments eventually deliver better outcomes for both the tax authority and taxpayers, even if they don’t immediately reduce costs.
In addition, the shift to upstream compliance shows that HMRC compliance officers are increasingly focusing on prevention rather than cure and is thinking systemically rather than transactionally. However, without key metrics for measuring improvement, it is difficult to see whether this approach is reaping benefits.
