Taxes totalling almost £5.2 billion were written off by HM Revenue and Customs last year, according to a report published by official auditors today.
Meanwhile, HMRC's accounts for 2011/12 showed it overpaid around £2-£2.5 billion in tax credits and underpaid up to £290 million as a result of fraud and error, said the report by the National Audit Office. A target of reducing the level of fraud and error to 5% of tax credit entitlements was missed.
The chairman of the influential House of Commons Public Accounts Committee, Margaret Hodge, said she was shocked by "the sheer scale of waste and mismanagement" at HMRC.
Over the last two years, the report found there had been a "large increase" in the amount of tax which HMRC has decided not to pursue - including £756 million worth of income tax in 2011/12 alone. Total tax debts being pursued stood at £13.3 billion at the end of March, down from £15 billion the year before.
The department met its target of reducing tax credit debts from £4.7 billion to £4 billion by March this year, but only after writing off old debts totalling £1.7 billion. It estimates that £2.3-£4 billion of tax credit debt is unlikely ever to be recovered.
The 2011/12 total of £5.17 billion in write-offs and remittances - debts which have been dropped because they are too small to be worth pursuing or would cause hardship if collected - included £1.5 billion in income tax, £1.9 billion in VAT, £653 million in National Insurance and £503 million in corporation tax.
The figure was down on the £5.5 billion write-offs and remittances in 2010/11, but still made up more than 1% of the total £474.2 billion tax collected.
Overall revenue increased by £4.5 billion (0.96%) in 2011/12, while the amount raised by VAT increased by £9.3 billion, largely because of successive hikes in the purchase tax from 15% to 20% between 2010 and 2012. But the Government took in less money from corporation tax.
The NAO also reported progress in tackling problems in the PAYE service which emerged following the introduction of a new administration system in 2009.
The report found that HMRC had met its target of processing 6.7 million PAYE cases relating to the previous two tax years and was on track to clear a backlog of cases dating back to before the new system by December this year.
But the stabilisation of the PAYE system came at a cost, as the taxman remitted £12.7 million worth of claims in 2011/12, bringing the total amount to £53.7 million.
Ms Hodge said: "Sadly it is no surprise that the NAO has found substantial problems with the HMRC's accounts. This year has seen a litany of tax errors and scandals come to light with mistakes made at the most senior level from the permanent secretary for tax downwards.
"The sheer scale of waste and mismanagement at HMRC never ceases to shock me. Without even mentioning the tax gap, in 2011/12 the department wrote off a staggering £5.2 billion of tax owed, overpaid nearly £2.5 billion in tax credits due to fraud and error and underpaid around £290 million.
"In some areas the department is moving in the right direction and has made progress to implement improvement plans. But the department is still plagued by IT problems; limiting, for example, its ability to link together the debts owed by taxpayers across different tax streams.
"With its long history of large scale IT failures, the department needs to get a grip before it introduces its new real-time PAYE information systems and begins the high-risk move from tax credits to the universal credit."
NAO head Amyas Morse said HMRC had a number of lessons to learn before the introduction of universal credit, which will replace a range of existing benefits and tax credits in 2013.
"Our high-level recommendations in today's report are that, first, the department should get a better understanding of the costs and benefits of its interventions - such as debt campaigns and initiatives to drive down levels of error and fraud in tax credits," said Mr Morse.
"Secondly, it should prioritise and target its activities on the basis of a better understanding of risks, such as risk-profiling of taxpayers.
"Finally, before implementing significant structural changes, the department needs to be clear about what its future operating model will be: it needs to understand how its business will change following the introduction of real-time information and universal credit.
"There are broad lessons here which reinforce the messages in our recent value-for-money work on tax administration. The department should seek to apply those lessons across the full range of its activities."
An HMRC spokesman said: "HMRC has collected £474.2 billion in tax revenues this year - the highest-ever total. We have increased our tax take by £4.5 billion against a very challenging economic backdrop.
"The £5.2 billion debt written-off figure relates to irrecoverable debt, where there is no practical way to pursue the liability - for example, the taxpayer cannot be traced or has gone bankrupt - and tax debt remitted, where HMRC decides not to pursue a tax debt because of reasons such as hardship or value for money. This amount has fallen from £5.5 billion in the previous year.
"Forty million people are taxed through PAYE, and that is one reason the modernisation of PAYE to create a system fit for the 21st century was so important.
"Today's report recognises the new system has bedded in well, and the legacy cases we inherited from the old clerical system are well on the way to being cleared.
"We have a long way to go before we are delivering the standards of service to which we aspire, but today's report reflects the real strides forward the department has made, and sets solid foundations for the future."
Robert Oxley, campaign manager of the TaxPayers' Alliance pressure group, said: "It's ludicrous that the taxman is missing out on billions because of our complex and burdensome tax system.
"HMRC is giving up on vast sums every year while families and businesses struggle to navigate one of the longest tax codes in the world. We need radical reform to create simpler taxes that would restore legitimacy to our broken system. Tax shouldn't be so taxing that even HMRC can't keep on top of it."