VAT under the microscope: how much money is lost due to tax settings and collection

How much can tax collection realistically be increased without raising rates? An illustrative answer is provided by value added tax, which is the most significant tax in the Czech tax system in terms of revenue. In 2023, the state collected approximately CZK 573 billion in VAT, and European statistics allow us to distinguish fairly accurately where potential additional revenues are "lost."

The first area is the so-called VAT compliance gap, i.e., the difference between the theoretical VAT revenue if the applicable legislation were fully complied with and the amount actually collected. In other words, it is the impact of tax evasion, errors in tax returns, insolvencies, and late payments. The European Commission has estimated this shortfall in Czechia at approximately CZK 50 billion, which corresponds to about 8% of potential revenue. A zero compliance gap is unachievable in practice, but international comparisons show room for improvement: while the EU average is 9.3%, Austria is around 0.6% and Finland around 1.5%. More effective collection, control mechanisms, and digitization could thus bring significant additional revenue without changing the law.

The second, and significantly larger, area is the so-called VAT policy gap, i.e., the loss of revenue caused by the tax setting itself. This is further divided into the rate gap and the exemption gap. The rate gap expresses the difference between actual collection and hypothetical revenue if the basic VAT rate were applied to all consumption. In the Czech case, unifying the rates would mean a theoretical increase in revenue of approximately CZK 83 billion. The exemption gap represents lost revenue resulting from VAT exemptions and activities that are not subject to VAT at all. Its total volume is estimated at up to CZK 430 billion, but a substantial part is effectively unchangeable – either due to European legislation, technical impracticability (e.g., imputed rent), or the nature of public non-market services. The part that can be realistically influenced, the so-called actionable exemption gap, is around CZK 125–130 billion.

The sum of the rate gap and the actionable exemption gap gives the so-called actionable policy gap of approximately CZK 210 billion. This is the upper limit of what could be achieved by optimizing the VAT design. Together with the potential reduction in the compliance gap, the theoretical maximum scope for increasing VAT collection reaches up to CZK 260 billion, even without changing the basic tax rate.