VAT Gap: Frequently asked questions
European Commission - MEMO/13/800 19/09/2013
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Brussels, 19 September 2013
VAT Gap: Frequently asked questions
What is VAT?
VAT is a consumption tax, charged on most goods and services traded for use or consumption in the EU. It is levied on the "value added" to the product at each stage of production and distribution. The "value added" means the difference between the cost of inputs into the product / service and the price at which it is sold to the consumer. VAT is charged when VAT-registered (taxable) businesses sell to other businesses (B-2-B) or to the final consumer (B-2-C). VAT is intended to be "neutral" in that businesses are able to reclaim any VAT that they pay on goods or services. Ultimately, the final consumer should be the only one who is actually taxed. Businesses are given a VAT identification number and have to show the VAT charged to customers on the invoices.
The VAT system in the EU is governed by a common legal framework - the VAT Directive. In the EU, there is a minimum standard VAT rate of 15%, above which Member States are free to set their own national VAT rates. Member States decide how to spend the revenue they receive from VAT receipts, except for a small percentage of this total (around 0.3%) which is paid towards the EU budget.
VAT is one of the main sources of government revenue for all Member States, accounting for around 21% of total general government revenues, or 7.5 per cent of GDP.
What is the VAT Gap?
The VAT Gap is defined as the difference between the expected VAT receipts if all the VAT which is due is collected and the actual VAT collected by Member States. It is calculated, in this study, on the basis of national consumption figures in government accounts. The calculations also take on board the specificities of each national tax system i.e. the various reduced rates, exemptions etc when assessing the expected/theoretical VAT receipts.
It is important to stress that the VAT Gap does not only relate to fraud and evasion, but also to legal tax avoidance, bankruptcies, financial insolvencies, miscalculations and the performance of tax administrations. For example, in the UK, 1/3 of the VAT Gap in 2009-10 was due to legal tax avoidance.
Why did the Commission sponsor this study?
Prior to this study, the most recent estimates for the VAT Gap dated back to 2006. The aim of this study is to quantify the VAT Gap for the period 2007-11, and to better understand the recent trends in the EU in the field of VAT collection. This can then help to shape and target policy measures to improve VAT compliance, and the figures can serve as a yardstick against which progress in this field can be assessed.
The study also allowed the scope to be extended to include Bulgaria and Romania, who were not members of the EU when the previous study was carried out. Croatia is not included in today's study, however, as it was not yet an EU member when the data was being collected. Cyprus is not covered by today's study either, due to revisions to its national accounts that are currently underway.
What are the main findings of the VAT Gap study?
The VAT Gap across all 26 Member States in 2011 accounted for €193 billion, or 1.5% of GDP. This amounts to 18% of the theoretical VAT (i.e. all expected revenue).
Italy (€36 bn), France (€32bn), Germany (€26.9bn) and the UK (€19bn) contributed over half of the total VAT Gap in quantitative terms, mainly because these are the largest EU economies. In terms of ratio to their own GDP, Romania (€10bn), Greece (€9.7 bn), Lithuania (€4.4bn) and Latvia (€0.9bn) were the countries with the largest VAT Gap in 2011
The study shows a marked upward trend in the VAT Gap in many Member States since 2008, as a result of the economic crisis. This was especially the case in Spain, Greece, Latvia, Ireland, Portugal and Slovakia. On average across the EU, the VAT Gap increased by 5 percentage points once the economic crisis hit.
(For illustrative table of all Member States' data, see tables in Annex)
What has been the effect of the economic crisis on the VAT Gap?
The data show that up to 2008, there had been a moderate declining trend in the level of the VAT Gap, particularly in a number of post-accession countries.
However, from 2008, the VAT Gap in many (but not all) countries increased with recession and the financial crisis from 2008. Spain, Greece, Latvia, Ireland, Portugal and Slovakia saw the highest increases in their gaps.
On the other hand, Sweden, Poland, Malta, Bulgaria and the Czech Republic were able to improve VAT collection levels during this period, and reduce their VAT Gap.
Taking into account the various components of the VAT Gap, there are several factors which can explain the increase in VAT GAP in times of crisis. On the one hand, sharp increases in VAT rates to redress public finances, particularly when coupled with poor enforcement, may have deterred compliance to some extent. On the other hand, the increase in insolvencies and bankruptcies, and a drop in imports (which often represent the easiest VAT collection to enforce) would also have contributed to the increase in the VAT Gap.
Figures and graphics available in PDF and WORD PROCESSED
What is the Policy Gap, which is also discussed in the study?
The VAT Gap is related to non-compliance under national tax rules. The Policy Gap, on the other hand, looks at the difference between the revenues that Member States could get if they applied uniform taxation to all consumption, and compares it to the revenues they actually get due to the various tax expenditures in their systems (e.g. reduced rates and exemptions).
The study shows considerable dispersion in the Policy Gap across Member States, ranging from the lowest in Romania (14%) to the highest for Spain and Poland (48%).
The Policy Gap is also a significant figure to take into account when considering how Member States could use their VAT systems to better effect for fiscal consolidation. In fact, the average Policy Gap (36%) is approximately twice as high as the average VAT Gap (17%) across the EU. This shows that the most important loss of VAT revenue is not due, in fact, to non-compliance (VAT Gap) but due to policy choices which have resulted in multiple rates and exemptions in national tax systems.
This confirms the Commission's consistent position that Member States should broaden their tax bases and minimise exemptions and reductions in order to improve the efficiency of their tax systems. This would not only result in substantial new revenue, but it would also create simpler tax systems for businesses to work within, thereby facilitating greater compliance.
What do findings suggest are amongst the most important contributors to the VAT Gap?
The VAT Gap study suggests that non-compliance varies substantially amongst Member States, and also over time and depending on the economic climate. Understanding these patterns is a step towards improving VAT compliance amongst all Member States, which in turn will lead to economic and fiscal benefits.
Econometric estimates of the determinants of the VAT Gap show that VAT compliance tends to fall when tax rates are increased and when national tax systems compromise multiple rates and exemptions (i.e. are more administratively complicated). This is the case at least in countries with weaker tax enforcement. In addition, VAT compliance appears to fall during recessions for the reasons already outlined above.
Overall, what can be concluded from today's study and other econometric analysis is that tackling the VAT Gap effectively requires a well-considered mix of both policy adjustments (e.g. broadening the tax base) and enforcement actions (e.g. stronger deterrents against evasion, improved audits and controls etc).
What is being done at EU level to reduce the level of non-compliance in VAT?
In December 2011, the Commission launched an ambitious reform of the EU VAT system.
Among the core objectives of this Strategy were to make the VAT system more robust and fraud-proof, and to simplify VAT so as both to facilitate greater compliance and ease the lives of businesses across the EU.
Since this Strategy was launched, important progress has been made towards these objectives.
In terms of better fighting VAT fraud, an important proposal which has already been adopted is the Quick Reaction Mechanism (see IP/12/1508), which will allow Member States to swiftly and effectively respond to new cases of massive fraud. Since 2010, Eurofisc has also been functioning as a very effective network to enable Member States to exchange information and intelligence on VAT fraud. The Fiscalis programme and the Copmmission also support Member States in the exchange of best practices in various forums, and encourages national authorities to engage in joint audits where this could add value. In 2014, the Commission will present a report on Member States' implementation of all anti-fraud measures related to VAT, and on that basis it will point to where further action is needed in this area.
In terms of simplifying the VAT system, already at the beginning of 2013 important new legislation entered into force to encourage e-invoicing and ease administrative burdens for small businesses. On 1 January 2015, a one-stop-shop will come into effect for businesses supplying e-services or telecom services, to ease compliance for those operators. And in the coming weeks, the Commission will also propose a standard VAT declaration form which will greatly simplify the process of VAT returns for cross-border businesses in the EU.
In addition to action at EU level, national authorities also need to take all necessary measures to improve compliance and strengthening enforcement on VAT fraud. This has been strongly and consistently relayed to Member States through the country specific recommendations for better economic governance. While each national situation requires its own particular approach, measures such as simplifying the tax system and broadening the tax base, and clamping down harder on those that evade VAT, can make a considerable difference in terms of VAT revenues.
On 28 November 2013, the Brussels Tax Forum will bring together high level tax experts from across the EU to focus specifically on how VAT can be made more efficient. This will be an opportunity to discuss the possibilities for improvements, to exchange ideas and share best practices.
Figures and graphics available in PDF and WORD PROCESSED