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The European Union (EU) VAT Gap, a key measure of the difference between expected VAT revenue and the amount actually collected, reached €89 billion in 2022. This marks an increase from the 2021 figure of €76 billion, reflecting ongoing challenges in VAT compliance across the 27 EU Member States. The VAT Gap, often linked to issues such as tax fraud, avoidance, and insolvencies, now represents 7.0% of the total VAT liability, up from 6.6% in 2021.
Key drivers of the VAT gap
1. VAT fraud and evasion: VAT fraud, including carousel fraud, remains a major challenge for EU Member States. Fraudsters exploit cross-border trade and weaknesses in reporting systems to evade VAT payments. According to Innovate Tax, the shift to e-commerce and the complexity of tracking digital sales have further exacerbated these challenges. Fraudulent activities not only widen the VAT Gap but also distort competition and place compliant businesses at a disadvantage.
2. Insolvencies and economic pressures: Business closures and insolvencies significantly impact VAT revenue. When companies cease trading, the VAT owed on outstanding invoices often goes uncollected. Although economic pressures have eased since the peak of the COVID-19 pandemic, financial strain on businesses continues to affect VAT compliance. This is particularly pronounced in sectors such as hospitality and retail, where cash flow issues are more prevalent.
3. Structural weaknesses in collection systems: Inefficiencies in VAT collection systems across certain Member States contribute to higher VAT Gaps. The complexity of tax compliance, coupled with differences in administrative capacity and resources, creates disparities in performance. Countries with less robust tax infrastructures often face higher VAT Gaps as a result.
Disparities among EU member states
The VAT Gap varies significantly across EU countries. While some Member States have maintained tight control over VAT compliance, others have struggled to reduce losses. For instance, according to VATCalc, Romania recorded the largest VAT Gap at 36.7% of its total VAT liability, followed by Malta at 25.7% and Greece at 17.8%. In contrast, the Netherlands achieved a negative VAT Gap of -0.2%, effectively collecting more VAT than initially estimated, while Finland (0.4%) and Spain (0.8%) also recorded exceptionally low gaps.
Measures to address the VAT gap
1. Digital reporting and E-Invoicing: The introduction of digital VAT reporting and e-invoicingElectronic invoicing - widely referred to as e-invoicing - is the exchange of a digital document between a supplier and a buyer. E-invoices are issued, transmitted and received in a structured data format that enabled automatic and electronic processing. They contain data in a machine-readable format so that an AP system can read an invoice without manual data entry, leading to faster and more efficient invoicing. systems has been instrumental in improving compliance. Real-time transaction reporting allows tax authorities to detect anomalies and prevent fraudulent activities at an early stage. EU-wide initiatives such as the 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.) project aim to make real-time reporting the standard across all Member States, enabling more accurate tracking of intra-EU trade.
2. Strengthening cross-border cooperation: EU Member States have enhanced cooperation to combat VAT fraud through initiatives like Eurofisc, a network that facilitates information sharing between tax authorities. Cross-border collaboration enables quicker identification of suspicious transactions, particularly those related to carousel fraud, which relies on the movement of goods across EU borders.
3. Addressing inefficiencies in tax administration: Improving the efficiency of VAT collection systems is crucial for reducing the VAT Gap. Member States with smaller VAT Gaps typically have well-developed tax infrastructures, streamlined audit procedures, and the capacity to enforce compliance. Simplifying VAT rules and reducing administrative burdens for businesses also contribute to higher compliance rates.
Implications for EU policy
The increase in the VAT Gap to €89 billion highlights the ongoing challenge for EU policymakers in ensuring VAT compliance. While technological advancements and cross-border cooperation have yielded progress, persistent issues such as fraud, insolvencies, and administrative inefficiencies remain obstacles. The EU’s commitment to the VAT in the Digital Age (ViDA) initiative is seen as a critical step towards modernising VAT collection and closing the VAT Gap.
