The VAT Gap, which illustrates the variance between expected and actual VAT revenues, serves as a barometer for measuring the effectiveness of VAT enforcement and compliance. It highlights crucial areas for potential improvement in tax administration. It is a critical metric for understanding how much revenue is lost due to various factors such as tax fraud, evasion, avoidance, and administrative errors.
Reducing the VAT Gap also aligns with broader sustainability goals. By improving tax compliance and increasing revenue collection, governments can allocate more funds towards sustainable development projects, public services, and infrastructure. This ensures that economic growth is balanced with environmental and social well-being, contributing to a more sustainable future.
Broadly, VAT Gaps are categorized into Compliance Gaps and Policy Gaps, both crucial for understanding the leakage in VAT collections.
- VAT Compliance Gap: The VAT Compliance Gap measures the difference between the theoretical VAT revenue (assuming full compliance) and the actual VAT revenue collected. This gap accounts for non-compliance, including illegal activities (such as tax evasion and fraud) and legal avoidance strategies, as well as errors and omissions in tax reporting. The compliance gap is influenced by several factors, including the effectiveness of tax administration, enforcement measures, and the taxpayers’ willingness to comply.
- VAT Policy Gap: The VAT Policy Gap reflects the revenue lost due to the application of reduced VAT rates and exemptions compared to a single standard VAT rate applied to all taxable goods and services. The policy gap shows the impact of government policy decisions on VAT revenue. It can be divided into: (a) Rate Gap: the loss of revenue due to the application of reduced and super-reduced VAT rates to specific goods and services; and (b) Exemption Gap: The loss of revenue due to exemptions from VAT for certain goods, services, or sectors. This can include non-taxable activities, zero-rated items, and services like healthcare, education, and financial services.
Key Insights from the EU’s VAT Dynamics in 2024
In 2022, the EU’s VAT compliance shortfall reached EUR 89.3 billion, signaling challenges in VAT collection efficiency across member states. This section explores the VAT compliance discrepancies across the EU, emphasizing the urgent need for strategic interventions in VAT enforcement.
Key Findings from the 2024 Report
- In 2022, the total VAT compliance gap in the EU amounted to EUR 89.3 billion, or 7% of the VAT Total Tax Liability (VTTL). Compared to 2021, this represents an increase of EUR 13.3 billion and 0.4 percentage points.
- The median VAT compliance gap in the EU was 6% of the VTTL, with the smallest gaps observed in Cyprus (-0.7%), Portugal (1.3%), and Ireland (1.7%). The largest gaps were in Romania (30.6%), Malta (25.9%), Slovakia (14.6%), and Lithuania (14.6%).
- The VAT policy gap in the EU27 was 49.6% of the notional ideal revenue in 2022. This gap remained stable despite inflation relief measures. The largest parts of the policy gap were exemptions for public services and imputed rents.
- Actionable VAT policy gap averaged 19.3% of the VTTL, highlighting the potential for significant revenue gains through policy changes.
Hungary
In Hungary, the VAT compliance gap was more than 19 ppts lower in 2022 than in 2013.
In 2014, Hungary introduced online cash registers for several sectors. Also, starting in 2014, the country’s domestic reverse charge mechanism was gradually extended. In 2015, the Electronic Public Road Trade Control System (EKÁER) was introduced to combat MTIC (Missing Trader Intra Community) fraud. In 2018, a real-time invoice-reporting requirement was implemented. The system was gradually extended, and in January 2024 the new eVAT platform was confirmed. It goes beyond the OECD’s SAF-T and is linked to fiscal cash registers, among other things.
Hungary’s VAT Gap Reduction Chronology
Below we detail Hungary’s commendable journey towards reducing its VAT Gap through a series of strategic policy implementations and technology integrations over the years.
2013: Introduction of Online Cash Registers: Initially set at 21.67%, Hungary’s VAT Gap saw a significant decrease following the introduction of online cash registers, which facilitated real-time data capture and tax collection.
2014-2016: Continued Improvement: With the VAT Gap dropping to 19.10% in 2014 and further to 16.48% by 2015, Hungary’s consistent efforts in improving VAT reporting and enforcement showed tangible results.
2017-2019: Enhanced Measures: A further drop was achieved with 14.30% in 2017, reducing to a remarkable 10.21% by 2019 following the implementation of stringent online invoice reporting requirements for B2B transactions reaching and surpassing a specific VAT threshold.
2020-2021: Broadening the Data Reporting Scope: The extension of online invoice data reporting to B2C and removing transaction thresholds saw the VAT Gap shrink to 8.13% in 2020 and a further decline to 4.74% in 2021, indicating strong compliance and reporting mechanisms.
2022-2023: Design of eVAT and Transition: The design and communication of an eVAT system in 2022-23 helped lower the VAT Gap to 2.31%, positioning Hungary as a model in VAT compliance efficiency.
2024: Integration of eVAT and eInvoice Systems: Hungary fully integrated the data matching processes between the eVAT and eInvoice systems, aiming at further reducing the VAT Gap by fostering greater data accuracy and real-time auditing capabilities.
Conclusion: Towards Optimized Taxation via Learning from Hungary’s VAT Strategy
The VAT Gap is a crucial indicator for assessing the effectiveness of VAT collection and policy implementation. By understanding and addressing the different components of the VAT Gap, governments can improve compliance, optimize tax policies, and enhance revenue collection for public services and infrastructure.
Hungary’s proactive and technologically advanced approach to tackling VAT fraud has yielded impressive outcomes, dramatically lowering the VAT Gap. Hungary’s example offers valuable lessons in the role of technology and policy in crafting effective tax compliance frameworks, setting a benchmark for other nations striving for similar success in maximizing public revenue through optimal VAT collection.
Hungary’s approach to reducing the VAT Gap also aligns with broader sustainability goals. By improving tax compliance and increasing revenue collection, the government can allocate more funds towards sustainable development projects, public services, and infrastructure. This ensures that economic growth is balanced with environmental and social well-being, contributing to a more sustainable future.
