Macroeconomic and Institutional Drivers of the VAT Gap across EU Countries

Identifying the reasons behind the value added tax gap is important for policymakers because it helps them understand areas in which tax compliance can be improved, and revenue losses decreased. The purpose of this paper is to examine the determinants of value added tax gap among a panel of 26 European Union countries during the period from 2000 to 2022. Through the analysis of the relationship between macroeconomic variables and the value added tax gap, the present work intends to provide useful information that could help making decisions that could help increase compliance rates and reduce the loss of revenues. The complicated relationship between income inequality and the value added tax gap requires further investigation into its mechanisms. The value added tax gap is not a universal concept but rather a result of complex interactions of various economic, institutional, human capital, and social factors that occur differently depending on the type of compliance. In high- value added tax gap countries, value added tax evasion occurs because of income inequality, underinvestment, and informal economy. On the other hand, in low- value added tax gap countries, compliance is achieved through educational systems, stability of the labor market, and proper exemptions. On the whole, the results show that policies which are context-sensitive and take into consideration structural inequalities in high-gap member states and institutional strengths in low-gap member states are crucial for successfully decreasing the value added tax gap within the European Union.