The Anatomy of the VAT

IMF Working Papers, May 16, 2013

Source details

Title: The Anatomy of the VAT
Author: Michael Keen
Date: May 16, 2013
Type: IMF Working Papers
Summary (as provided): This paper sets out some tools for understanding the performance of the value added tax (VAT). Applying a decomposition of VAT revenues (as a share of GDP) to the universe of VATs over the last twenty years, it emerges that developments have been driven much less by changes in standard rates than by changes in ‘C-efficiency’ (an indicator of the departure of the VAT from a perfectly enforced tax levied at a uniform rate on all consumption). Decomposing C-efficiency into a ‘policy gap’ (in turn divided into effects of rate differentiation and exemption) and a ‘compliance’ gap (reflecting imperfect implementation), results pieced together for EU members suggest that the former are in almost all cases far larger than the latter, with rate differentiation and exemptions playing roles that differ quite widely across countries.

Developments in VAT revenues (as a share of GDP) over the last twenty years have been driven much less by changes in standard rates than by changes in “C-efficiency”.
C-efficiency is defined as an indicator of the departure of the VAT from a perfectly enforced tax levied at a uniform rate on all consumption.
C-efficiency can be decomposed into:
- a “policy gap”, which is further divided into effects of rate differentiation and exemption; and
- a “compliance” gap, reflecting imperfect implementation.
For EU members, the “policy gap” is in almost all cases far larger than the “compliance” gap.
Rate differentiation and exemptions play roles that differ quite widely across countries.

Applies a decomposition of VAT revenues (as a share of GDP) to the universe of VATs over the last twenty years.
Decomposition focuses on isolating effects of standard rate changes, C-efficiency, policy gap (rate differentiation and exemption), and compliance gap.

Changes in standard VAT rates are less important drivers of revenue outcomes than changes in C-efficiency.
Policy measures aimed at reducing the policy gap (for example, addressing rate differentiation and exemptions) are likely to have larger effects on VAT revenue performance than measures solely focused on standard rate adjustments.
The relative importance of rate differentiation versus exemptions varies significantly across countries, implying that country-specific diagnostic work is needed to identify the most effective policy levers.
Compliance improvements matter, but for EU members examined, compliance shortfalls are typically smaller than policy-driven gaps.

The Anatomy of the VAT; by Michael Keen; IMF Working Paper 13/111; May 1, 2013
- The Anatomy of the VAT; by Michael Keen; IMF Working Paper 13/111; May 1, 2013 (Markdown version)
- The Anatomy of the VAT; by Michael Keen; IMF Working Paper 13/111; May 1, 2013 (PDF)