By developing and implementing a detailed strategy to increase taxpayer compliance and collections, an OECD country boosted its tax revenues.
Due in large part to recent financial pressures, an OECD government had become increasingly aware of its “tax gap”—the difference between the total taxes owed to the government and the amount that taxpayers pay voluntarily and on time. The country’s tax authority sought McKinsey’s help in developing a data-driven strategy to increase taxpayer compliance with the tax code and to improve the collection of outstanding tax payments.
The McKinsey team started by sizing the opportunity. The team analyzed the tax gap, first breaking it down into its components: nonfiling, underreporting, and underpayment. Then, based on data from the tax authority and from McKinsey’s proprietary tax-benchmarking database, the team quantified the scale and identified the drivers of each component. OECD countries, for instance, have tax gaps ranging from 10 to 50 percent—that is, 10 to 50 percent of taxes owed aren’t paid—and the majority of noncompliance comes from underreporting by small businesses and self-employed individuals.
Having quantified and analyzed the potential for improvement, the McKinsey team worked with the client to develop a detailed strategy for improving compliance and collections. Using more information sources than the tax authority historically had relied on, the team came up with a series of innovative ways to deter noncompliance, including integrating third-party data to improve identification of nonfilers and underreporters. The team also used advanced statistical techniques and modeling approaches—such as neural networks to detect complicated fraud patterns—to develop a more systematic taxpayer segmentation, define at-risk groups, and customize treatments for each segment in order to enhance compliance. Finally, the team developed a set of early interventions and targeted tools to improve collections, including setting up prefiling interactions (for example, electronic alerts to businesses reminding them to submit quarterly employment taxes).
The new approaches and techniques helped the tax authority realize significant additional tax revenue while improving taxpayer service.
In the area of compliance, the team’s recommendations helped reduce the national tax gap by between 10 and 15 percent, equivalent to 1 to 2 percent of the country’s total tax liability. They also helped improve taxpayer service by minimizing mistakes up front, aided case selection by making better information accessible to tax examiners, and increased voluntary compliance by raising taxpayer awareness.
In addition, the new strategy boosted the efficiency of collections and nearly doubled collection rates, halving the amount of uncollected tax debt each year.