HM Revenue and Customs (HMRC) has lost £2 billion a year in failing to achieve its aims of stemming the cash-in-hand culture.
A report published today by the committee of public accounts, found that over £2 billion could have been lost in taxes through the hidden economy which involves an estimated two million people.
Edward Leigh MP, Chairman of the committee said: "HMRC is apparently making little ground in its efforts to diminish the cash-in-hand culture operating in the UK."
HMRC spent £41 million in 2006-07 on encouraging people and businesses into the formal economy and detecting and imposing sanctions on those who operate within the hidden economy.
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From 2003-04 the department detected 30,000 cases of people not declaring taxes, a rate of detection of only 1.5 per cent. The amount of tax raised from detected cases has, however, increased by 13 per cent since 2003/04.
The department has failed to match their goals of detection. They only completed 2,000 investigations compared to the 5,500 planned, which amounted in £2.6 million tax assessments opposed to the planned £32.5 million.
HMRC possesses the power to impose a penalty of 100 per cent of the tax owed but often enforces penalties much lower. In 2006-07 the department imposed penalties of £5 million, only 3 per cent of the possible tax identified.
While prosecutions rose to 69 in the year 2006-07, they failed to gain much publicity, limiting the effect of prosecution as a deterrent to the wider community.
Mr Leigh added: "HMRC has no solid estimate of the level of losses but it might be over £2 billion a year. With a detection rate of only 1.5 per cent, the chances of being caught are very slight.
"For those who are caught, the penalties imposed are usually relatively trifling: on average only 3 per cent of the tax detected. And in very few cases, just two out of a thousand, is a prosecution launched."
To increase the detection rate the department has increased its use of data matching techniques and in 2005 set up the tax evasion hotline so members of the public can report suspicions of tax evasion.
There has been some more positive news for the government in the use of advertising campaigns, which led to 8,300 registrations and will result in £38 million in taxes over three years.
The Offshore Disclosure arrangement, introduced in 2007, has led to 45,000 people coming forward and disclosing their offshore accounts amounting to £400 million in new taxes.
The HMRC was formed in 2005 after the Inland Revenue and HM Customs and Excise departments merged.