Taxes totalling almost £5.2 billion were written off by HM Revenue and Customs (HMRC) last year, according to a report published by official auditors.
Meanwhile, HMRC's accounts for 2011/12 showed it overpaid between £2 billion and £2.5 billion in tax credits, and underpaid up to £290 million as a result of fraud and error, the report by the National Audit Office (NAO) said. 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 between £2.3 billion and £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.
Ms Hodge said: "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."
NAO head Amyas Morse said: "Our high-level recommendations 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. Secondly, it should prioritise and target its activities on the basis of a better understanding of risks, such as risk-profiling of taxpayers."