Can the EU Close the VAT Gap?

Introduction

The first session of the Tax Symposium dealt with an issue which is relevant to all European tax authorities: How do you best address the VAT gap and other compliance gaps without making the tax system unmanageable for businesses and taxpayers?

Declan Costello, Deputy Director-General for Economic and Financial Affairs at the European Commission, moderated the panel. The speakers were:

• Pierre Pimpie, Member of the European Parliament and member of the Subcommittee on Tax Matters
• Chryssa Miliou, Secretary General for Tax Policy, Ministry of Economy and Finance, Greece
• Ferenc Vágujhelyi, Commissioner, National Tax and Customs Administration of Hungary
• Eelco van der Enden, CEO, Accountancy Europe

This session had a good balance of tone. The panel members were aware that the VAT gap is not a problem that can be solved with a quick fix. While there was a general consensus among the members of the panel that governments have to collect more of the taxes which are already due, it was equally clear that the panel members were also aware of the risk that more pressure, more controls and more reporting does not necessarily mean a better tax system. 

The panel members returned repeatedly to the same basic principle. Tax collection will only improve when the system adapts.

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The VAT gap is not just a revenue problem

The starting point for the discussion was fairly obvious: the VAT gap is a measure of lost revenue that negatively impacts tax efficiency. Today, governments are increasingly facing budgetary pressures and are being called upon to deliver more with less. A number of speakers mentioned broader areas such as social welfare expenditure, public stability and new spending priorities (defence and security) as well as linking these to the potential loss of government revenue. Although the session did not characterise the issue solely as a revenue shortfall, the amount of money that is missing may be missing for a variety of reasons. Fraud is one reason, poor reporting, inadequate coordination, complexity and/or a lack of administrative capacity may be another. Therefore, the VAT gap is indicative of the health of the entire tax system. That is why the conversation moved rapidly away from the punitive aspects and towards the type of system that would facilitate compliance; make it harder for fraudsters and prioritize enforcement.

Closing the VAT gap cannot rely on enforcement alone

Nobody in the room advocated for eliminating audits and sanctions. That was not the issue. The issue was that audits and sanctions alone cannot sustain the entire system.

A tax administration that relies too heavily on enforcement may, in the process, merely add further burden to taxpayers rather than addressing the underlying causes of non-compliance. This appeared to be a major area of concern in the session. If the rules governing tax compliance are overly complex, if there is a lack of coherence in reporting systems or if ordinary taxpayers find it difficult to determine what is expected of them, increasing pressure is unlikely to provide a solution.

Differentiation was another aspect of this. The panel differentiated between basic mistakes, deliberately delaying payment and fraudulent activity by organised criminal groups. These differences are significant, because they demand different approaches. An individual who has made a mathematical error should be dealt with differently than an organisation involved in structured carousel fraud.

Simpler systems were presented as anti-fraud policy

Simplification was the most frequently repeated theme in the session. It was viewed as a fundamental component of compliance strategy. Historically, overly complex systems generate opportunities for errors. They generate loopholes. The more difficult a system is to navigate, the greater opportunity there will be for some individuals/organisations to take advantage of the gaps and for other organisations to fall behind unintentionally.

This is particularly relevant to VAT where reporting chains, invoicing requirements and cross-border issues can rapidly become technical. The panel's broader message was that governments should seek to identify whether their own systems are generating unnecessary friction. This was also related to competitiveness. Simpler systems reduce compliance costs. They reduce the time spent on compliance. They reduce the risk that businesses (particularly smaller businesses) become bogged down in formalities.

A key takeaway from the session is that the simplification of tax systems should not be viewed as a 'softer' approach to enforcement, but rather a 'smarter' one.

Digitalisation dominated the session, but with real caution attached

If there was one practical theme that dominated the session, it was digitalisation. Digitalisation was cited as a method of improving the accuracy of real-time reporting, facilitating electronic invoicing, enhancing the use of existing data, automating the reconciliation of transactions, utilising artificial intelligence (AI) in audit processes, and providing pre-filled returns. The panel clearly view digital reform as a future direction for tax administrations. That was evident. No participant referred to technology as if it had the capability to solve all issues on its own.

One concern expressed regarding technology was the danger of reliance. Technology can highlight unusual behaviours, recognise patterns, and assist the authority in deciding which areas to investigate. However, technology cannot independently assess whether an investigation is warranted. Ultimately, a determination regarding suspicion of wrongdoing still requires human judgement. The session repeatedly referred to this point, especially in terms of fairness and the threat to honest taxpayers.

Additionally, some of the speakers were concerned regarding the increased dependence upon private platform-based e-invoicing models, particularly as these private platforms would retain large volumes of highly sensitive information related to transactions and financial information. This aspect of the discussion provided a significant dose of reality. Reducing fraud is one matter; creating new vulnerabilities within a system is quite another.

Therefore, the tone on digitalization was supportive, but cautionary, with a focus on slow and steady modernization.

Trust, fairness, and compliance culture were treated as hard policy issues

Compliance culture was the second key issue that emerged during the session. The panel devoted considerable time to the concept that tax systems operate effectively based on control (i.e., enforcement) as well as whether individuals understand the tax rules; trust the tax authority; and believe the tax system to be fair. Where taxpayer trust is weak, voluntary compliance is likely to weaken. Conversely, where taxpayer trust is strong, the tax authority requires less reliance on enforcement mechanisms to maintain compliance. Thus, the session had a somewhat broader context than mere administrative tools or legal design. It included taxpayer experiences within the tax system.

In practice, if taxpayers view the tax laws as inequitable, overly complex, or inequitably administered, voluntary compliance will weaken. Additionally, once voluntary compliance weakens, the cost of enforcement rises for all parties. In addition to being a vague aspiration, developing a more effective compliance culture impacts the amount of pressure the state must place upon taxpayers to collect taxes.

It appeared that the panel treated trust, predictability and fairness as practical components of tax collections and not as abstract values independent of tax collection.

The EU’s role: coordination without flattening sovereignty

As previously indicated, the cross-border aspect was a topic discussed throughout virtually all aspects of the session. Cross border fraud is far easier to commit than cross border administration. Reporting mechanisms vary. Data is collected differently. Information does not flow rapidly. These differences create gaps that can be exploited.

The session clearly established that the EU has a critical role to play. The value the EU can contribute to solving cross-border issues primarily relates to improving the efficiency and effectiveness of national systems operating cooperatively. As such, this includes interoperability; rapid transfer of data; technical coordination; and common frameworks that facilitate cooperative actions to reduce cumbersome procedures.

Despite the differing views among participants relative to EU level alignment, the apparent consensus among participants was that fragmented national systems are hindering enforcement efforts.

This, therefore, represented one of the most realistic discussions. The problem is not that each country has its own tax system. The problem is when those systems fail to communicate appropriately in an increasingly globalized economy.

Conclusion

Taken as a whole, the session was more about an approach to thinking rather than about one particular reform effort. Instead of suggesting that the VAT gap could be reduced using one specific mechanism, one specific technology, or one round of additional enforcement, the panel suggested a more comprehensive framework: making compliance easier wherever possible; using data more efficiently; improving reporting; focusing enforcement on intentional violations of the law; and keeping human judgment involved in the enforcement decision-making process.

This is what ultimately defined the session. The session was a discussion about what an effective tax system should look like today. The direct takeaway is that closing the VAT gap is about developing a system that is more transparent and effective at distinguishing between an honest mistake and a malicious act.

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