Mind the VAT gap (and take a closer look)

The VAT compliance gap has an important “upstream” impact on transaction tax compliance developments throughout the EU. 

The phrase refers to the difference between expected VAT revenues and the amount of VAT that is actually collected, in absolute or percentage terms, each year. The term “VAT Total Tax Liability” (VTTL) – which is the estimated amount of VAT that is theoretically collectable based on VAT legislation and related rules – represents a more precise description of expected VAT revenues.  

The VAT gap provides a measure of the effectiveness of VAT compliance and enforcement in each EU Member State. A higher VAT gap means that more fraud, tax avoidance, bankruptcies, financial insolvencies and/or miscalculations occurred during the year. It also means that the EU and individual Member States are more likely to consider implementing new measures and rules to reduce fraud, tax avoidance and miscalculations. Among other objectives, the EU’s VAT in the Digital Age (ViDA) proposal seeks to reduce the VAT gap by simplifying strengthening VAT compliance via new e-invoicing and digital reporting rules. 

This is to say that the EU’s 11th annual VAT gap report is worth minding, and mining, for insights. The research analyzes 2021 figures and how those statistics compare to the previous four years, but in addition it also includes some 2022 VAT gap estimates. 

Here are some notable high-level findings: 

• The overall EU VAT Gap continues to decrease: The overall gap declined from approximately €99 billion in 2020 (which amounts to 9.6% of the VTTL) to €61 billion in 2021 (5.3% of the VTTL). This roughly €38 billion reduction represents an “an unprecedented improvement on previous years,” according to the report. Two of the highest individual Member State VAT Gap reductions from 2020 to 2021 occurred in Italy (-10.7 percentage points) and Poland (-7.8 percentage points), both countries with a clear focus on expanding their VAT compliance mandates.  
• There are some major outliers: The median VAT compliance gap across all 27 Member States was 4.9% of the VTTL in 2021. The countries with the smallest VAT compliance gaps include the Netherlands (-0.2 percent), Finland (0.4 percent), Spain (0.8 percent) and Estonia (1.4 percent). The Netherlands negative gap is likely due to a statistical or measurement error that can occur when non-compliance is very low. The highest VAT compliance gaps for 2021 were in Romania (36.7 percent), Malta (25.7 percent), Greece (17.8 percent) and Lithuania (14.5 percent). In absolute terms, Italy (EUR 14.6 billion), France (EUR 9.5 billion) and Romania (EUR 9.0 billion) posted the largest VAT gaps in 2021.  
• This is good news, with a caveat: The large decrease in the compliance gap over a four-year period (including the COVID-19 pandemic and the short recession it triggered) seems counterintuitive, but there are sound reasons for this. The report’s analysis indicates that the decrease stems from several factors, including the enactment of COVID support measures that were contingent on paying taxes, a decline in bankruptcies, changes in consumption patterns and the growth of cashless payments. The report also notes that data availability has declined.  Approximately 60% of the detailed data previously available for past analyses was made available for the current report, which is described as sufficient for analytical purposes.  

Does a declining VAT gap mean that taxpayers can expect fewer changes to VAT rules and reporting requirements? Probably not. The report also details a variety of tax administration reforms and new compliance measures such as e-invoicing and (near) real-time reporting in countries that recorded substantial improvements in VAT compliance from 2013 to 2021. The success of these changes is likely to inspire similar adjustments in other Member States.