What Is The Value-Added Tax (VAT) Gap And Why Is It Important?
The VAT Gap, i.e. the difference between expected VAT revenues and VAT collected in the government coffers, provides an estimate of revenue loss due to tax fraud and inadequate tax collection systems. The sheer size of losses on the global scale explains why officials at national treasuries worldwide are ramping up the efforts to close the gap.
According to the European Commission, EU member states failed to collect around 137.5 billion euros in taxes in 2017. The loss represents 11.2% of the total expected VAT revenue, despite the fact the collected VAT revenues during 2017 increased at a faster rate (4.1%) than the VAT Total Tax Liability (2.8% increase).
The difference between the expected VAT revenue and the amount actually collected is commonly known as the VAT Gap. Numbers vary across the member states, from negligible 0.6% in Cyprus and 0.7% in Luxembourg to 35.5% in Romania and 33.6% in Greece. Of those figures, more than a third, according to EU officials, is related to cross-border VAT fraud, which amounts to 100EUR per EU citizen each year.
According to common framework, VAT is defined as a “broadly based consumption tax applied to all commercial activities involving the production and distribution of goods and services”. The modern version of VAT was introduced in the 1950s in France and Germany and was subsequently adopted as an efficient tool for measuring the success of countries’ economies.
As the adoption of VAT was continuously spreading worldwide, so too were the numerous forms of tax fraud schemes or errors. Therefore, the VAT gap, in short, is a common measure (far from being precise) of leakage in the system, related to tax fraud and inadequate tax collection systems, presented in absolute or percentage terms. In a way, the VAT gap simply measures the effectiveness of tax enforcement and compliance, depicting the success of the various actions related to the intensified crackdown on tax avoidance.
While acknowledging the VAT as a major revenue source for EU member states, EU commissioners proposed a far-reaching reform of the VAT system, hoping to enforce tighter compliance and reduce the VAT gap by 80%, which puts the EU at the forefront of the tax harmonization drive. Meanwhile, the picture is still pretty bleak on a global level, and the numbers revealed in the latest EU study simply underrate the sheer scale of the problem.
Broad estimates of the VAT gap globally are pointing to a loss of 20% to 30% of the public revenue, i.e. 500EUR billion annually. Hence the VAT gap, while being a major headache for national treasuries worldwide, it also becomes the main accelerator for the fiscal digitalization, making e-invoice one of the indispensable tools of improved tax collection policy, with a grand purpose of resolving the tax loss and – closing the gap.