## tnm1704

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**Canonical URL:** [tnm1704](https://www.imf.org/-/media/files/publications/tnm/2017/tnm1704.pdf)

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### I. How countries measure noncompliance and VAT revenue impacts
- Three main approaches to estimate VAT noncompliance:
  - Top-down approach: gap = estimated potential revenue − actual revenues; does not identify specific compliance behaviors.
  - Bottom-up approach: uses random sampling for audit or compliance risk analysis; identifies behavioral sources, can test top-down estimates; covers only identified sources and is costlier.
  - Econometric techniques: frontier analysis, time series analysis; sensitive to determinant selection and assumptions; not recommended as primary tools to estimate the tax gap itself.
- RA-GAP top-down approach advantages:
  - Breaks the VAT gap down by sectors of activity and by basic administrative functions (collections versus assessment).
  - Models potential revenue to closely follow how a typical credit-invoice VAT operates, allowing precise modelling of country VAT policy structures.
  - Uses an accruals-based methodology, improving matching between statistical measures for economic activity and revenue collections and facilitating tracking of efforts to close the gap over time.
- Practical note: Several countries publish tax-expenditure estimates for VAT reliefs; more countries are publishing estimated revenue losses due to noncompliance despite measurement challenges.

### II. Definition and decomposition of the VAT gap (RA-GAP)
- Core definitions:
  - Tax gap (RA-GAP) = difference between potential revenue of the underlying economic tax base and actual revenue.
  - Compliance gap = impact of noncompliance (using current statutory framework).
  - Policy gap = impact of policy choices (tax expenditures, reliefs).
- RA-GAP top-down estimation steps (summary):
  - Step 1: Estimate reference potential revenue, RPR.
  - Step 2: Determine actual revenue, AR.
  - Step 3: Tax gap = RPR − AR.
- Compliance gap (current policy framework):
  - Step 1: Estimate potential revenue under current policy, CPR.
  - Step 2: Determine actual revenue, AR.
  - Step 3: Compliance gap = CPR − AR.
- Policy gap = RPR − CPR (equivalently, tax gap − compliance gap).
- Important caveat: Closing the policy gap would not necessarily yield full revenue equal to RPR because compliance rates associated with removing tax expenditures may differ from current average compliance.

### III. RA-GAP measurement components and reporting
- Three methodological components:
  1. Method for estimating potential revenue.
  2. Method for measuring actual revenue.
  3. Methods for reporting derived gap figures.
- Reporting conventions:
  - Tax gaps reported in relative terms (gap value divided by relevant potential revenue base).
  - Alternative presentation: express gaps as a share of GDP for trend analysis and fiscal impact clarity.
  - RA-GAP presents gap values both relative to their relevant tax base and relative to GDP.
- Interpretation note: A 30 percent policy gap and a 30 percent compliance gap are not nominally equal because denominators differ.

### IV. Potential VAT revenue: value‑added model (preferred RA-GAP method)
- Core modelling principle: apply VAT policy framework to a model of value-added by sector (mirrors taxpayer liability: tax on imports + tax on domestic output − creditable input tax).
- Data inputs: national accounts supply‑use or input‑output tables to estimate:
  - Potential VAT on imports by sector.
  - Potential VAT on domestic output by sector (exports subtracted).
  - Potential VAT credits on intermediate demand and gross fixed capital formation by sector.
- Key policy variables and adjustments:
  - VAT rate vector set from current tax rate schedule for CPR and assigned the standard rate for RPR.
  - Proportion of value-added produced by entities registered for VAT (registration proportion) applied to outputs and credits; often estimated from business surveys or tax declaration data.
  - Proportion of output that is taxable determined by comparing exempt output in a sector to total output; binary indicator for commodity exemption status (= 1 if exempt, = 0 if taxable).
  - Policy variable for input-credit disallowances denotes proportion of a purchase for which input credits are denied; for full potential collections all values set to one (1).
- Assumption: same registration proportion assumed across O, X, I, and N; consequence small if registration proportion is close to one.

### V. Alternate demand-side method and RA-GAP preference
- Alternate/common method: base model on final consumption and demand-side data (estimate VAT paid by consumers + VAT borne by exempt businesses using intermediate demand statistics).
- Theoretically equivalent to the value-added approach via national accounts identity Y = C + I + X − M.
- RA-GAP preference: value-added approach because it allows sectoral disaggregation of the VAT gap for sector-by-sector gap estimates using taxpayer registry data.

### Adjustments for statistical vs. tax treatments (X and M, trade margins, and policy complexities)
- Exports in national accounts include domestic consumption by nonresidents; imports include consumption abroad by residents — adjust final consumption accordingly for reference potential revenue.
- Reallocations between sectors and agents may be required (use customs data or business survey data); reallocations affect sectoral distribution of the gap but not overall level.
- Where specific data missing, use Balance of Payments debit/credit for travel services or approximate by removing values for services typically consumed at place of supply (hotel and restaurant supplies, local transportation supplies).
- Weighted average statutory rate for trade margins: use breakdown of margins by commodity type in supply tables to calculate a margin-weighted VAT rate for retail and wholesale sectors.
- Accommodating complex policy structures:
  - Business-to-business treatments: extend tax rate specification to vary by commodity and sector of supplier, or by commodity, supplier sector, and purchaser sector.
  - Business-to-consumer treatments: either expand model with special goods/services categories or separately estimate revenue impacts of special treatments using household consumption survey data or tax-expenditure estimates.

### Actual VAT revenue: alternative measures and RA-GAP choice
- Four measures for actual VAT (measurement varies by reference period and data source):
  1. Net revenue (Date of Transaction; Transactions) — operational performance indicator.
  2. Accrued net revenue (Tax Period; Transactions) — operational performance indicator.
  3. Assessments (Assessments; Assessments) — operational and gap measurement; potential to understate compliance gap because not all assessed liabilities are paid.
  4. Accrued collections (Transactions; Transactions for transactions, Accrued Collections for net revenue) — hybrid designed to best measure underlying taxpayers’ compliance; preferred by RA-GAP.
- Definitions and issues:
  - Net revenue: transactions/payments and refunds in the period; affected by lags, refunds, single taxpayer account issues.
  - Accrued net revenue: reallocates transactions to tax periods in which liabilities or credits arose; better aligned with economic activity.
  - Assessments: uses assessed VAT due; not all assessed amounts are paid; may incentivize inflated assessments if relied upon.
  - Accrued collections: uses payments for debits and assessments for credits; adjusts for excess-credit carry-forward by treating offset amounts as additional VAT payments.
- RA-GAP preferred actual VAT basis for compliance-gap measurement: accrued collections.

### Measuring and reporting the gap components (operational decomposition)
- Definitions:
  - VAT gap = potential VAT − actual VAT (actual VAT on accrued collections basis; potential VAT under reference policy framework).
  - Compliance gap = potential VAT (current policy framework) − actual VAT (accrued collections basis).
  - Policy gap = potential VAT (reference policy framework) − potential VAT (current policy framework).
- Operational decomposition of compliance gap:
  - Collections gap: difference between what taxpayers have declared/assessed as due and amount of VAT collected.
  - Assessment gap: difference between total declared/assessed amounts due versus total potential VAT which should have been declared/assessed (CPR).
  - Collections gap can be computed by subtracting accrued collections from assessments or by subtracting assessment gap from the compliance gap.
- Sectoral breakdown guidance:
  - Break compliance gap by sector to prioritize investigative resources.
  - Use gap per taxpayer, output-to-input ratio changes, outliers, and time series anomalies to guide enforcement strategy.

### Accuracy, limitations, and tracking changes over time
- Accuracy drivers:
  - Dependent on national accounts statistics and modelling assumptions.
  - National accounts typically not published with quantifiable margins of error; revisions between preliminary and final GDP can change by several percentage points.
  - Given potential sizeable margins of error, focus analysis on trends rather than levels.
- Systemic biases:
  - Biases in national accounts may be systemic (regular over- or under-estimation), making trend changes more informative than levels.
  - RA-GAP rule of thumb: changes are significant once they exceed a half percentage point of GDP.
- Standardized measures for temporal comparability:
  1. The initial gap — measured at original filing/payment deadline; indicator of voluntary compliance and does not change over time.
  2. The gap as of (specified date) — any subsequent gap estimate must indicate the extraction date (e.g., “the gap as of May 1, 2015 was 30 percent”).
  - Regular, periodic measurement (e.g., anniversary of filing/payment deadline) is encouraged to monitor administration performance in closing the compliance gap.
- Final remarks on RA-GAP strengths:
  - Value-added approach better replicates the policy structure of a VAT and allows sectoral breakdown.
  - Accruals-based actual VAT measure improves matching with economic activity and allows clearer distinction between collection and assessment gaps.
  - Observed empirical note: RA-GAP’s value-added approach should produce the same overall estimate of the compliance gap as the demand-based approach where both have been employed.

*Source: TNM/17/04 — 2. How accurate is this measure of the gap?*

### References ....................................................26

### tnm1704 - References ....................................................26

### I. How countries measure noncompliance and VAT revenue impacts
- Several countries publish estimates of the fiscal impact of VAT reliefs (tax expenditures), often derived from independent data such as household expenditure surveys or relieved supplies declared by taxpayers.
- Noncompliance revenue losses are harder to measure because noncompliant behaviors are unlikely to be declared and may be concealed; nonetheless an increasing number of countries produce and publish estimated revenue losses due to noncompliance.
- Three main approaches used to estimate VAT noncompliance:
  - Top-down approach: measures the gap as the difference between estimated potential revenue and actual revenues, typically using statistical data; does not identify specific compliance behaviors.
  - Bottom-up approach: uses techniques such as random sampling for audit or compliance risk analysis to estimate impacts of specific behaviors; gives behavioral insight and can test top-down estimates but covers only identified sources and is costlier.
  - Econometric techniques: tools such as frontier analysis and time series analysis can estimate efficiency or revenue losses but are sensitive to determinant selection and assumptions; not recommended as primary tools to estimate the tax gap itself.
- RA-GAP (Revenue Administration–Gap Analysis Program) top-down approach advantages:
  - Breaks the VAT gap down by sectors of activity and by basic administrative functions (collections versus assessment).
  - Models potential revenue in a way that closely follows how a typical credit-invoice VAT operates, allowing precise modelling of country VAT policy structures.
  - Uses an accruals-based methodology, improving matching between statistical measures for economic activity and revenue collections and facilitating tracking of efforts to close the gap over time.

### II. Definition of the "Value-Added Tax Gap" under IMF RA-GAP
- Tax gap (RA-GAP definition) = difference between potential revenue of the underlying economic tax base and actual revenue.
- Tax gap decomposition:
  - Compliance gap: impact of noncompliance.
  - Policy gap: impact of policy choices (tax expenditures, reliefs).
- RA-GAP top-down estimation steps (summary):
  - Step 1: Estimate reference potential revenue, RPR (Box ACHE in Figure 1).
  - Step 2: Determine actual revenue, AR (Box ABFD).
  - Step 3: The tax gap = RPR-AR.
- Compliance gap estimation (using current statutory framework):
  - Step 1: Estimate potential revenue under current policy, CPR (Box ACGD).
  - Step 2: Determine actual revenue, AR (Box ABFD).
  - Step 3: The compliance gap = CPR-AR.
- Policy gap = RPR - CPR (equivalently, tax gap minus compliance gap).
- Note: Closing the policy gap would not necessarily yield full revenue equal to RPR because compliance rates associated with removing tax expenditures may differ from current average compliance.

### III. RA-GAP measurement components and reporting
- RA-GAP methodology broken into three components:
  1. Method for estimating potential revenue.
  2. Method for measuring actual revenue.
  3. Methods for reporting derived gap figures.

### IV. Potential VAT revenue: value-added model
- Preferred RA-GAP method: apply VAT policy framework to a model of value-added for each sector; mirrors taxpayer liability determination: tax on imports + tax on domestic output (exports zero-rated) − creditable input tax.
- Works with national accounts data (supply-use or input-output tables) to estimate:
  - Potential VAT on imports by sector.
  - Potential VAT on domestic output by sector (exports subtracted).
  - Potential VAT credits on intermediate demand and gross fixed capital formation by sector.
- Potential revenue model notation and components:
  - Equation (1): model expressed by sector s where the total potential VAT revenue is the sum across sectors of: potential VAT on imports of sector s; potential VAT on output of sector s; minus potential VAT creditable on inputs of sector s. (Equation label: (1))
  - The model allows sectoral breakdown by not summing over s.
- Potential VAT on imports (component equation (2)):
  - Determined by imports by sector s of commodity c from national accounts and the VAT rate that applies to commodity c (zero if zero-rated or exempt).
  - Vector of VAT rates, denoted (policy variable), is set from current tax rate schedule for CPR and assigned the standard rate for RPR.
- Potential VAT on output (component equation (3)):
  - Uses output by sector s of commodity c and exports by sector s of commodity c from national accounts.
  - Exports are subtracted to derive taxable domestic output.
  - Multiplied by a policy variable that reflects proportion of value-added in sector s produced by entities registered for VAT (the threshold/registration effect).
  - The value for the registration proportion often must be estimated (e.g., from business survey or other tax declaration data).
- Potential VAT credits on inputs (component equation (4)):
  - Uses intermediate consumption and gross fixed capital formation by sector s of commodity c from national accounts.
  - Adjusted by:
    - the proportion of output for a sector which is exempt output (policy variable),
    - the proportion of input tax credits for commodity c by sector s allowed to be claimed (policy variable).
  - Input VAT credits are limited to registered entities; the policy variable for registration applies to this term as well.
- Treatment of exempt output:
  - Proportion of output that is taxable is endogenously determined by comparing exempt output in a sector to total output (equation (5)).
  - A binary indicator distinguishes whether commodity c is exempt (= 1) or taxable (= 0).
- Policy variable for input-credit disallowances:
  - Variable denotes proportion of a purchase for which input credits are denied (e.g., entertainment expenses); values for current potential collections determined from statutes; for full potential collections all values set to one (1).
- Assumption noted:
  - Same registration proportion is assumed across O, X, I, and N; consequence small if registration proportion is close to one.

### V. Alternate demand-side method (Box 1)
- Alternate/common method: base model on final consumption and demand-side data, estimating VAT paid by consumers and adding an estimate of VAT borne by exempt businesses using intermediate demand statistics.
- Theoretically equivalent to the value-added approach by national accounts identity: Y = C + I + X − M, which can be rearranged to express final consumption as C = M + O − X − N − I.
- RA-GAP prefers value-added-based approach because it allows disaggregation of the VAT gap by sector of collection, enabling sector-by-sector gap estimates using taxpayer registry data.

*Source: Technical Notes and Manuals 17/04 | 2017 (tnm1704 - References ....................................................26)*

### 2. Accounting for differences between statistical treatments and tax treatments

### 2. Accounting for differences between statistical treatments and tax treatments

### Adjustments for Variables X and M
- National accounts definitions:
  - Exports include the domestic consumption by nonresidents.14
  - Imports include the value of consumption abroad by residents.15
- Typical destination-based VAT treatment:
  - Domestic consumption by nonresidents is taxable (although some countries might provide refunds for some or all of this VAT).16
  - Consumption abroad by residents is not taxable.16
- Implication for reference potential revenue:
  - Adjust final consumption to include domestic consumption by nonresidents and exclude consumption abroad by residents.
  - Supply-and-use tables should specifically include data on the value for these special categories of imports and exports for use in adjusting the tables.17
- Reallocations between sectors and agents:
  - National accounts associate exports with sector of production and imports with sector of consumption, while tax treatment depends on the agent of the transaction.
  - Customs data can reallocate imports to the agent of import rather than final destination.
  - Business survey data on export volumes can be employed to reallocate exports.
  - These reallocations affect distribution of the tax gap across sectors but not the overall level of the gap.
- Where specific data is not available:
  - Data on debit and credit for travel service on Balance of Payments can be another source of information.17
  - Otherwise approximate by removing values for import or export of services typically consumed at place of supply (hotel and restaurant supplies, local transportation supplies).17

### Determining a weighted average statutory rate for the trade margins
- Context:
  - In National Accounts Statistics, output of retail and wholesale sectors are recorded as trade margins; gross sales and inputs related to the transactions are not recorded.
  - Different VAT rates may apply across commodities sold by retail and wholesale sectors (e.g., standard rate on automobiles but a zero rate on pharmaceuticals).
- Method:
  - Using a breakdown of margins by commodity type in a supply table, calculate a weighted average VAT rate for retail and wholesale margins:
    - where:
      - = the weighted average VAT rate for the margins of the retail and wholesale sectors;
      - = the VAT rate for commodity , where  includes all commodities except for services of the retail and wholesale sectors; and
      - = the value of the retail and wholesale margins associated with commodity .

### Accommodating complexities in the policy structure
- Model policy variables:
  - The three policy variables (, , ) can model most policy structures, but additional adjustments are needed for specific policies in two categories:
    a. Business-to-business treatments
    b. Purchaser-specific rates (business-to-consumers)
- Business-to-business treatments:
  - Examples: exemptions for supplies between certain taxpayers or classes (micro businesses under threshold), exemptions for classes of activity (financial service providers), different rates depending on purchaser (zero-rating fuels when supplied to international airlines).
  - Exemptions affect overall level of tax gap; special rates mainly affect distribution across sectors.
  - Accommodation in model:
    - Extend tax rate specification to vary by commodity and sector of supplier, c,s, or by commodity, sector of supplier, and sector of purchaser, c,ss,sp.19
- Business-to-consumer treatments:
  - Two methods to reflect special treatments:
    1. Expand the model by creating special goods and services categories (e.g., food for elderly people), reflecting specific tax rates and transaction flows.
    2. Separately estimate revenue impacts of special treatments and adjust model results.
  - Estimation requires household consumption survey data or existing tax expenditure estimates for transactions dependent on nature of consumer (income group, age, etc.).

### Actual value-added tax revenue — decomposition and measurement options
- Decomposition:
  - Actual VAT can be expressed as sum of:
    - VAT on imports;
    - VAT due on outputs; and
    - VAT creditable for inputs in the period.
  - Notation in source:
    - = actual VAT for sector s;
    - = VAT on imports for taxpayer t active in sector s;
    - = VAT on output of taxpayer t; and
    - = creditable VAT on inputs of taxpayer t.
  - Sector information typically available from taxpayer registry, making sectoral breakdown feasible.
- Alternative expression:
  - Actual VAT = VAT on imports + domestically declared net VAT for taxpayers in a debit position () + domestically declared net VAT for taxpayers in a credit position ().
  - where  and .
- Four measures for actual VAT (Table 1 summary; measurement varies by reference period and data source):
  1. Net revenue (Date of Transaction; Transactions for data sources) — used as general operational performance indicator.
  2. Accrued net revenue (Tax Period; Transactions) — used as general operational performance indicator.
  3. Assessments (Assessments; Assessments) — used as general operational performance indicator and tax gap measurement.
  4. Accrued collections (Transactions; Transactions for transactions, Accrued Collections for net revenue) — used for tax gap measurement.

#### 1. Actual VAT: net revenue
- Definition:
  - Uses date of transaction of payments and refunds regardless of tax period (compiles all transactions made in the period).
- Provides information about net cash collections or newly available cash for the government during the period.
- Issues:
  - Lags in collection cause fluctuations between potential VAT revenues and actual collections due to operations, not compliance.
  - Lags in payment of refunds cause differences.
  - Single taxpayer account systems may cause over-reporting of net VAT and under-reporting of other taxes if intra-tax transactions are not properly recorded.21
  - Net revenue may not appropriately reflect changes in taxpayers’ compliance because of timing, refunds, and excess credit carry-forward mechanisms.

#### 2. Actual VAT: accrued net revenue
- Definition:
  - Reallocates transacted amounts to the tax periods in which tax liabilities or credits arose.
- Issues:
  - Better associated with economic activities in each tax period and more meaningful to compare with potential VAT.
  - Still affected by excess credit carry-forward mechanisms and single taxpayer accounts.

#### 3. Actual VAT: assessments
- Definition:
  - Uses assessment data from taxpayer self-assessments and additional assessments from the revenue authority — a measure of VAT due.
- Issues:
  - Not all assessed liabilities are paid; assessed amount may understate the overall compliance gap.22
  - Relying on assessments to measure compliance can create incentive for inflated assessments by the revenue authority.
  - Still useful to compare against potential VAT; potential VAT minus actual VAT assessments is the “assessment gap,” one component of the compliance gap.

#### 4. Actual VAT: accrued collections
- Definition:
  - Hybrid of accrued net revenue and assessments: uses payments data for debits () and assessments for credits ().
  - Designed to best measure underlying taxpayers’ compliance.
- Adjustment for offsetting via excess credits:
  - Because many countries allow/require carrying-forward excess credits, offset amount (excess credits used to reduce positive VAT liabilities) should be regarded as additional VAT payments.
  - Modified actual VAT equation includes:
    - = net accrued VAT collection for sector s;
    - = VAT on imports for taxpayer t;
    - = actual VAT payments received from taxpayer t for the period;
    - = excess credits of taxpayer t used to reduce a positive VAT liability for the period; and
    - = domestic net VAT credits (excess credits) for taxpayers in a credit position.
  - Determining  when not tracked:
    - If Excess-credit, carried forward for taxpayer t >= positive VAT due, then  = positive VAT due; otherwise  = Excess-credit, carried forward for taxpayer t.

#### Choosing which version to use
- Choice depends on purpose:
  - Net revenue and accrued net revenue: operational purposes.
  - Assessments and accrued collections: gap estimation purposes.
- The RA-GAP framework uses accrued collections as the preferred actual VAT basis for compliance-gap measurement.

### Measuring and reporting the gap
- Definitions:
  - VAT gap = potential VAT − actual VAT (actual VAT on accrued collections basis; potential VAT estimated using the reference policy framework).
  - Compliance gap = potential VAT (current policy framework) − actual VAT (accrued collections basis).
  - Policy gap = potential VAT (reference policy framework) − potential VAT (current policy framework).
- Presentation conventions:
  - Tax gaps reported in relative terms rather than nominal values to avoid inflation-driven distortions.
  - Relative expression: divide gap value by relevant potential revenue base; VAT gap and components expressed as .
  - Alternative presentation: express gaps as a share of GDP for trend analysis and fiscal impact clarity.
  - Note on interpretation:
    - A 30 percent policy gap and a 30 percent compliance gap are not nominally equal because denominators differ: potential VAT under reference policy framework is larger than potential VAT under current policy framework, so a 30 percent policy gap will be nominally larger than a 30 percent compliance gap.23
- RA-GAP practice:
  - Presents gap values both relative to their relevant tax base and relative to GDP to allow nuanced trend assessment and cross-measure comparisons.

*Source: 2. Accounting for differences between statistical treatments and tax treatments — tnm1704*

### 2. How accurate is this measure of the gap?

### 2. How accurate is this measure of the gap?

### Accuracy drivers and limitations
- The accuracy of tax gap measures is highly dependent on national accounts statistics and on the modelling assumptions used.
- National accounts statistics are typically not published with margins of error; assumptions used are also subject to error margins that are not generally quantifiable.
- Because margins of error cannot generally be quantified, it is rarely appropriate to publish margins of errors for tax gap estimates.
- Indications of accuracy for national accounts statistics are generally constructed from an analysis of the degree of revisions made between preliminary and final published values.
  - Such an approach suggests the margin of error could be quite large, as estimates for GDP can change by several percentage points between revisions and could vary substantially from country to country.
- Given the uncertainty and the possibility that the margin of error could represent a sizeable portion of the estimated gap, analysis should focus more on trends than on levels.

### Implications of systemic biases
- It cannot be assumed that the margin of error in national accounts statistics is small compared to any estimated tax gap.
- It is more plausible that biases creating errors in national accounts are systemic (regular tendency to either over-estimate or under-estimate).
- If biases are systemic, changes and trends in the estimated gap are more accurate or indicative than the level.
- RA-GAP rule of thumb: changes are significant once they exceed a half percentage point of GDP.

### Breakdown of the VAT gap (summary of RA-GAP operational structure)
- Overall: VAT gap = compliance gap + policy gap.
- Compliance gap (operationally divided into two main components):
  - The collections gap: measures the difference between what taxpayers have declared as being due, or have had assessed as being due, and the amount of VAT collected.
  - The assessment gap: measures the difference between the total amounts declared or assessed as being due versus the total potential amount of VAT which should have been declared or assessed (CPR).
  - The assessment gap is estimated using actual VAT determined on the assessment basis (Box AJKD), subtracted from potential VAT estimated using the current policy framework (leaving Box JCGK).
  - The collections gap can be determined either by subtracting actual VAT determined on the accrued collections basis from actual VAT determined on the assessment basis, or by subtracting the assessment gap from the compliance gap (leaving Box BJKF).
  - These two measures help identify whether collection/enforcement operations or audit/assessment operations need strengthening.

### Sectoral decomposition guidance
- The compliance gap can be broken down by sector, useful for focusing investigative resources.
- The gap value per sector should be used with other business intelligence (sector composition and demographics).
  - A large sector gap may be spread across many taxpayers; a small sector gap may be concentrated in few taxpayers (potentially higher return on enforcement).
  - Operational intelligence may reveal organized criminal fraud in a sector, making it a priority.
- Additional indicators to consider:
  - Compliance gap per taxpayer in the sector.
  - Changes in output to input ratios across taxpayer segments (grouped by size of total output); reductions in this ratio signal potential general compliance issues; outliers indicate specific taxpayers with compliance issues.
  - Time series analysis of revenues per sector to identify unexpected changes or anomalies for further investigation.

### Breaking down the policy gap (normative policy framework and components)
- The policy gap is estimated using two distinct values for potential VAT: one under the current policy framework and one under an alternate (reference) policy framework.
- RA-GAP focuses on a specific alternate: the “normative policy framework.”
  - Items excluded from the tax base in the normative policy framework but included in the reference policy framework:
    i. Nonmarket public goods (e.g., public education and public healthcare) — included in final consumption in national accounts but not typically subject to VAT.
    ii. Imputed rents for residential housing stock — included in final consumption but not easily captured by VAT.
    iii. Margin-based financial services — typically exempt due to complexity.
- Using the normative policy framework, the policy gap is split into:
  - The expenditure gap: measured by subtracting potential VAT estimated using the current policy framework from potential VAT estimated using the normative policy framework.
  - The efficiency gap: measured by subtracting potential VAT estimated using the normative policy framework from potential VAT estimated using the reference policy framework, or by subtracting the expenditure gap from the policy gap.
- Purpose: identify revenue foregone due to policy choices by isolating components included for policy objectives (expenditure gap) versus those included for pragmatic reasons (efficiency gap).

### Tracking changes in the gap (standardized measures)
- Because actual VAT is an accruals-based measure, gap values change over time depending on when they are measured.
- RA-GAP uses two general, standardized, static measures for comparability over time and across jurisdictions:
  1. The initial gap.
  2. The gap as of (a specified date of measurement).

- The initial gap:
  - Measured at the original filing/payment deadline.
  - When measuring actual VAT on both assessment and adjusted collections bases, transactions and assessment data are filtered to select only payments and returns received by their respective deadlines.
  - This measure will not change over time and provides an indicator of voluntary compliance — a basis for comparison as the administration collects arrears, receives late filed declarations, and makes additional assessments.

- The gap as of...:
  - Any gap estimate made subsequent to the initial gap should indicate the timeframe of measurement (e.g., “the gap as of May 1, 2015 was 30 percent.”).
  - The timeframe is the period when new transaction and assessment data is extracted.
  - Ideally, gap measurements are performed regularly (e.g., anniversary of the filing/payment deadline) to provide insight into administration performance in closing the compliance gap over time.

### Final remarks (advantages of the RA-GAP approach)
- RA-GAP uses a model for potential VAT designed to employ statistics on value-added by sector rather than final consumption.
  - The value-added approach better replicates the policy structure of a VAT (mirrors the credit-invoice approach).
  - It allows for a break-down of the gap by sector, enabling a more nuanced understanding of the compliance gap for measurement and risk assessment.
- RA-GAP uses an accruals-based measure for actual VAT collections:
  - Allows more precision in matching economic activity in statistical data with taxpayer activity in the tax administration.
  - Permits more dynamic measurement of how the gap changes over time and a clearer distinction between the collection and assessment gap.
- Note: RA-GAP’s value-added approach should produce the same overall estimate of the compliance gap as the demand-based approach; this has been observed where both approaches have been employed.

*Source: TNM/17/04 — 2. How accurate is this measure of the gap?*

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_Source: https://www.imf.org/-/media/files/publications/tnm/2017/tnm1704.pdf_