EU reveals 2.5% increase in latest VAT gap report

Every year, the European Commission gathers all the data and publishes its findings on tax gaps. On the 11^th December, it released it’s latest ‘Mind the Gap’ 2023 report which offers a comprehensive look at tax gaps in the EU and its 27 Member States.

We’ll be focusing on the estimated tax gaps for VAT, but the report also does include an assessment on Corporate Income Tax (CIT) for those interested.

The tax gap can be broken down into two main components: the compliance gap and the policy gap.

The compliance gap estimates the difference between the money that could have been collected by governments and the money actually collected, due to non-compliance. This includes tax evasion, tax avoidance, bankruptcies or errors in reporting or payment. It was reported to be €89 billion in 2022.

Whereas the policy gap represents revenue lost due to policy changes, including tax expenditures such as exemptions, reduced tax rates or thresholds that narrow the tax base.

According to the latest available data, the EU VAT compliance gap was estimated at 9.5% of the VAT Total Liability, which amounts to €128 billion. Across Member States, this ranged from 1% to 30%.

Which countries reported the smallest compliance gaps?

1. Austria – 1%
2. Finland – 3%
3. Cyprus – 3%

Which countries reported the largest compliance gaps?

1. Romania – 30%
2. Malta – 24%
3. Poland – 16%

Key takeaway stats from the report

• Between 2022 and 2023, the gap increases in 17 Member States, while 9 Member States reported a decrease.
• The largest increased were observed in Ireland, Estonia, Hungry and Poland.
• Biggest improvements were estimated for Croatia, Slovenia and Cyrpus.
• Since 2000, there has been a steady increase in the number of EU countries with their own tax gap teams calculating their compliance gap.

Why has there been an increase?

During the COVID-19 pandemic in 2020-2021, the VAT compliance gap narrowed significantly, accelerating a pre-existing downward trend observed in the years leading up to the pandemic.

This improvement proved temporary, as in the years that followed, the compliance gap widened again as consumption patterns shifted towards sectors more prone to non-compliance, particularly services.

At the same time, the phasing out of COVID-19 support measures led to an increase in business bankruptcies, further weighing on VAT collection and contributing to the observed rise in the VAT compliance gap.

Lastly, the report notes that VAT estimates during 2020 and 2021 there were slight inconsistencies in deferrals and lower quality national statistics due to the turbulent circumstances. Some of the post-pandemic increase simply reflects a return to more normal economic activity and reporting patterns.

What about the policy gap?

The report also states a 50.5% VAT policy gap, driven by reduced rates and exemptions, with Spain (59.1%) and Greece (57%) having the highest policy gap levels, reflecting their retrospective policy choices.

Actions to reduce tax gaps

• Digital compliance – Accelerating the adoption of digital tools, including AI-driven analytics, can improve compliance risk management, administrative efficiency and taxpayer services. Forthcoming reforms such as VAT in the Digital Age (ViDAViDA or 'VAT in the Digital Age', is an EU initiative proposed by the European Commission that seeks to modernise and harmonise VAT processes for member states, by embracing new technologies. It is aimed at updating processes for the management of VAT, and reduce the VAT gap and fraud. The proposal also aims to address challenges in the area of VAT raised by the development of the platform economy.) are expected to further reduce VAT non-compliance.
• Fostering EU wide cooperation – Enhanced information exchange under the Directive on Administrative Cooperation is the cornerstone of effective tax compliance enforcement.
• Strengthen tax collection and recovery – Further automation and integration of tax IT systems, as well as connecting to third-party stakeholders, can improve the collection of due taxes and recovery of outstanding debts, particularly in relation to older and disputed liabilities.
• Review policy-driven revenue losses – Regular monitoring and evaluation of tax expenditures, reliefs and exemptions can help ensure that policy-induced tax gaps remain effective, proportionate and deliver value for money, particularly in a context of constrained public finances.
• Improve estimations – Member States can develop technical expertise and robust data systems to support regular tax gap estimation across tax types.

Overall, the 2023 Mind the Gap report highlights that while the VAT compliance gap narrowed during the pandemic, this improvement was temporary and challenges remain. The post-pandemic increase emphasises the importance of sustained investment in digitalisation, effective enforcement and regular policy review if Member States are to improve tax compliance across the EU.