Effects of the Reverse Charge Mechanism on VAT Gaps

The purpose of this paper is to evaluate the effect of reverse-charge mechanism (RCM) implementation on VAT compliance using an overall, country-level measure of VAT compliance, the VAT gap. The VAT gap is defined as the overall difference between expected and realized VAT revenues and is a broader measure than outcomes employed in previous research, incorporating all types of VAT evasion. Exploiting the staggered adoption of RCM across Europe and the size of industries targeted by RCM, we compare changes in the VAT gap before and after RCM implementation. Evidence from difference-in-differences, event study, and heterogeneous treatment effects estimators indicates that the adoption of the RCM does not lead to significant EU-wide changes on the aggregate VAT gap. Moreover, our results illustrate the mixed impacts of RCM on different goods and industries, with measurable decreases in VAT losses in the construction and industrial crops industries. This study’s findings do not provide strong support for policy changes that cast the net of the RCM wider on all industries and EU member states, although bilateral coordination in RCM adoption with top trading partners may assist in curbing VAT fraud relocation.