The Determinants of the VAT Gap

Understanding the factors that contribute to the VAT gap is crucial for policymakers, as it highlights areas where tax compliance can be improved, and revenue losses can be minimized. This study aims to identify and analyse the determinants of the Value Added Tax (VAT) gap across a panel of 26 EU countries for the period from 2000 to 2022. By investigating the relationship between key macroeconomic indicators and the VAT gap, the research seeks to provide insights that can inform policy decisions aimed at improving tax compliance and reducing revenue losses. The analysis employs a two-way fixed effects regression model to account for both country-specific and temporal heterogeneity. The model incorporates several macroeconomic indicators, including the Corruption perception index (CPI), Gini coefficient, Real GDP Growth, Size of the Shadow Economy, Unemployment rate, VAT Standard Rate. This methodological approach allows for a comprehensive examination of how these variables influence variations in the VAT gap across different countries and over time. This study contributes to the existing literature by highlighting the critical role of labour market conditions and income distribution in influencing tax compliance behaviour. The findings suggest that policies aimed at reducing unemployment could be effective in mitigating the VAT gap. Additionally, the nuanced relationship between income inequality and the VAT gap calls for further exploration of the underlying mechanisms, offering valuable insights for policymakers and researchers interested in tax policy and economic inequality. The study demonstrates that the VAT gap is not a uniform phenomenon but reflects complex interactions between economic structures, institutional quality, human capital, and social conditions that vary systematically across different compliance contexts. High VAT-gap countries are characterized by income inequality, investment deficits, and structural informality. Low VAT-gap countries depend on education, labour market stability, and careful exemption management for their compliance.