HM Revenue and Customs has admitted there is "more to be done" to provide a quality service after auditors revealed up to five million people could be paying the wrong income tax because of IT problems at the department.
In a report on HMRC's accounts for 2006-07, the National Audit Office warned that up to five million people may not be paying the right amount of income tax because the HMRC computer systems were "no longer well suited" to handling the tax.
The figure is five times higher than that identified in a separate report by the public spending watchdog, published earlier this month.
The new report says: "Based on its most recent estimates, each year the department may not be pursuing some £880 million (US$1.7 million) of tax due, and taxpayers are likely to have overpaid around £340 million, resulting in potentially five million taxpayers not paying the right amount of tax."
Sir John Bourn, head of the NAO, commented: "HMRC's computer systems are no longer well suited to the efficient administration of income tax, especially where people have more than one job or change jobs frequently."
The NAO report also revealed that overpayments of tax credits have now hit the £6 billion mark, with just £2 billion of this recovered so far. Levels of fraud and claimant error in the tax credit system were also "unacceptably high" and there was "no evidence to demonstrate a lower estimate for 2006-7".
HMRC Chairman Paul Gray said there was "still more to be done to ensure that we provide a high quality service to all our customers. ... We will take on board the NAO's recommendations and work closely with interested parties and stakeholders to help us to improve".
Gray said he was pleased the NAO had recognized the improvements HMRC had made to the quality of PAYE processing.
HMRC has put in place a range of measures to improve PAYE handling, including new software to replace manual data collation and tax code calculation, ahead of the implementation of a new computer system next year.
MPs focused their response to the NAO report on the long running tax credits fiasco. Edward Leigh MP, chair of the Commons Public accounts committee said taxpayers' money was "being wasted hand over fist" with fraud and error rates "running at a staggering billion pounds a year".
He added: "The reputation of HMRC for competence looks increasingly threadbare as revelations of this kind become public."
In a parliamentary debate on tax credits, new chancellor Alistair Darling acknowledged: "There were inevitably some administrative problems following its introduction, we are all aware of that."
"They need to be sorted out, and they will be sorted out," he told MPs. "However, it is important to keep sight of the fact that tax credits have benefited nearly 20 million families, and that many people with children are much better off as a result of our actions."
HMRC's Gray added: "We have reduced the amount of error and fraud in the tax credit system and I have put in place a fundamental review to accelerate the testing of levels of errors and fraud. This will enable us to set clear targets to reduce this further."