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European Commission

MEMO

Brussels, 23 October 2014

VAT gap: Frequently asked questions

See also IP/14/1187

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 and one of the three own resources of the EU.

What is the VAT Gap?

The VAT Gap can be defined as the difference between the amount of VAT actually collected and the VAT Total Tax Liability (VTTL), in absolute or percentage terms. The VTTL is an estimated amount of VAT that is theoretically collectable based on the VAT legislation. Accordingly, it takes into account reduced rates of VAT and exemptions, and is calculated by using data available on final and intermediate consumption, as well as gross fixed capital formation, from national accounts and use tables.

The VAT Gap can be seen as an indicator of the effectiveness of VAT enforcement and compliance measures as it arises as a consequence of revenue loss through cases of fraud and evasion, tax avoidance, bankruptcies, financial insolvencies as well as miscalculations. It should be stressed, though, that as the VAT Gap in this study is based on a top-down approach, it does not readily lend itself to be deconstructed according to industrial sectors or other criteria (territorial, professional).

Why did the Commission sponsor this study?

The 2012 Update Report to the Study to quantify and analyse the VAT Gap in the EU-27 Member States (hereafter: the 2012 Update report) provides estimates for the VAT Gap for 26 EU Member States for 2012 as well as revised estimates for the period 2009-20011. It is a follow-up to the report "Study to quantify and analyse the VAT Gap in the EU-27 Member States" published in September 2013 (hereafter: the 2013 VAT Gap report), which covered the period 2007-2011. The aim of the 2012 Update report and the previous 2013 VAT Gap report is to quantify the VAT Gap and to better understand the trends in the EU in the field of VAT collection. This can then help to address (policy) measures to improve VAT compliance and enforcement, and the figures can serve as a yardstick against which progress in this field can be assessed.

While it was hoped that the 2012 Update report would cover also Cyprus and Croatia, this has not yet been possible in view of the as-yet unfinished revision to the national accounts for Cyprus and the compilation of use tables for Croatia.

Why are estimates of the 2013 VAT Gap report revised?

In order to permit comparability of the estimates, the 2012 Update report also includes revised estimates for the years 2009-2011. The methodology employed is based on a top-down approach and is described in detail in the 2013 VAT Gap report. However, the estimates contained in the 2012 Update report have been produced through a different database than the one employed in the 2013 VAT Gap report. Since the completion of that report, revenue and national accounts data have become available for the year 2012 and Member States have almost completed the transition to NACE Rev. 2 and CPA 2008 classifications in their input-output framework, as mandated by ESA 95. The 2012 Update report therefore has adapted the estimates of the Gaps to the availability of the new database.

Overall, the VAT Gap estimates in the 2012 Update report compared to those in the 2013 VAT Gap report, for the EU-26 taken as a single unit are, in percentage terms, virtually identical for 2009, and show a somewhat lower value for 2010 and 2011. Accordingly, for 2011, the VAT Gap in the 2012 Update report is estimated at 16 percent in contrast to 17.59 percent (rounded up to 18 percent) in the 2013 VAT Gap report, a reduction of -1.6 percentage points. In absolute terms, the VAT Gap is estimated at Euro 171 billion in contrast to Euro 192 billion in the 2013 VAT Gap report, which represents a deviation of 11 percent.

What are the main findings of the 2012 Update report?

In 2012, the overall VAT Total Tax Liability (VTTL) for the EU-26 grew by about 2.2 percent, while collected VAT revenues grew just shy of 2 percent. As a result, the overall VAT Gap saw a slight increase in absolute numbers (about Euro 6 billion, to reach Euro 177 billion) in the EU-26, but remained essentially stable as a percentage of the overall VTTL, at 16 percent.

In 2012, the VAT Gap in individual Member States ranged from the low of 5 percent of Finland and the Netherlands, to the high of 44 percent in Romania. The median VAT Gap is about 15 percent. Table 3.1 provides an overview of the results of the VAT Gap estimates for 2011 and 2012.

The median absolute change in the VAT Gap of the individual Member States from 2011 to 2012 was 1.1 percent, with a number of countries registering considerably higher values. Overall, 11 Member States decreased their VAT Gap, with the largest improvements noted in Greece, despite the depth of its recession, and Bulgaria. However, 15 Member States saw an increase in the VAT Gap, ranging from virtually nil (e.g., Slovenia) to a substantial deterioration (e.g., Slovakia, Poland).

Table 3.1 - VAT Gap estimates, 2011-2012

2011

2012

Country

Revenues

VTTL

VAT Gap

VAT Gap %

Revenues

VTTL

VAT Gap

VAT Gap %

AT

23,447

27,009

3,563

13%

24,563

27,807

3,244

12%

BE

26,019

29,669

3,650

12%

26,896

29,887

2,991

10%

BG

3,362

4,434

1,073

24%

3,739

4,697

957

20%

CZ

11,246

13,602

2,356

17%

11,377

14,644

3,267

22%

DE

189,920

211,834

21,914

10%

194,040

215,997

21,957

10%

DK

23,870

25,916

2,047

8%

24,422

26,563

2,141

8%

EE

1,363

1,577

214

14%

1,508

1,763

255

14%

ES

56,009

68,913

12,904

19%

56,125

68,537

12,412

18%

FI

17,020

17,913

893

5%

17,640

18,545

905

5%

FR

140,558

163,417

22,859

14%

142,499

168,082

25,583

15%

GR

15,028

24,213

9,185

38%

13,713

20,364

6,651

33%

HU

8,516

11,252

2,736

24%

9,084

12,055

2,971

25%

IE

9,755

11,093

1,338

12%

10,219

11,482

1,263

11%

IT

98,456

143,916

45,460

32%

95,473

141,507

46,034

33%

LT

2,444

3,820

1,377

36%

2,521

3,957

1,436

36%

LU

2,792

2,937

145

5%

3,064

3,268

204

6%

LV

1,374

2,186

812

37%

1,570

2,389

818

34%

MT

520

733

213

29%

536

777

241

31%

NL

41,610

43,255

1,645

4%

41,699

43,699

2,000

5%

PL

29,843

36,798

6,955

19%

27,881

37,198

9,317

25%

PT

14,265

16,083

1,819

11%

13,995

15,223

1,228

8%

RO

11,412

20,382

8,970

44%

11,212

20,053

8,841

44%

SE

36,631

38,043

1,412

4%

37,861

40,748

2,886

7%

SI

2,996

3,277

282

9%

2,889

3,160

270

9%

SK

4,711

7,015

2,304

33%

4,328

7,114

2,787

39%

UK

130,683

145,724

15,041

10%

142,943

159,501

16,557

10%

Total

(EU-26)

903,848

1,075,015

171,167

16%

921,798

1,099,018

177,220

16%

Sources: Eurostat (revenues); Own calculations. Figures in million Euros unless otherwise indicated. National currency figures for countries not using the Euro converted at the average Euro exchange rate (source: Eurostat).

What is the Policy Gap?

The concept of the Policy Gap tries to capture the effects of discretionary decisions regarding multiple rates and exemptions on the revenue that could be “produced” by a given VAT system. It is defined as the ratio between the VTTL and the "ideal" VAT Revenue. The "ideal" VAT Revenue is estimated by applying the standard rate of VAT to aggregate consumption (thereby eliminating the effects of reduced rates and exemptions). Accordingly, the Policy Gap is an indicator of the additional VAT revenue that a Member State could theoretically collect if it applied uniform taxation to all consumption.

What are the main findings of the 2012 update report?

In the period 2009-2012, the Policy Gap is (much) higher than the VAT Gap in most Member States. This confirms the findings common in taxation literature as well as in the 2013 VAT Gap report, namely that in most countries the VAT revenue forgone compared to an “ideal system” without exemption and with a single rate (set at the prevailing standard rate) is due to policy choices rather than non-compliance and weak enforcement.

The median Policy Gap is about 43 percent. Member States with a Policy Gap lower than the median have an average VAT Gap of 23 percent, compared to an average 15 percent for the Member States with a Policy Gap above the median. Four of the countries with a lower Policy Gap than the median have a higher VAT Gap than their Policy Gap (Latvia, Lithuania, Romania and the Slovak Republic). Figure 3.3 displays the Policy Gap and the Vat Gap, averaged over 2009-2012.

Figure 3.3 – Policy Gap and VAT Gap in the EU-26 countries, 2009-2012


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