Greater transparency is key to combatting VAT fraud and the shadow economy, writes Jason Lane.
By Jason Lane, Group Executive, European Market Development, Mastercard.
Every year, national governments in Europe lose billions of euros in tax revenue, directly impacting public investments in schools, healthcare, infrastructure and other structural spending.
The European Commission’s recently published annual VAT Gap study indicates the situation has not improved in recent years and demonstrates an alarming trend. In 2014, over €160 billion was lost in the EU. This underscores that an effective tax collection system is paramount to improve fair tax collection for citizens and greater VAT revenue for governments.
EU and national governments are stepping up their efforts to clamp down on tax dodging. Yet, more work can be done to address the shadow – or undeclared – economy. While the shadow economy has a number of components, the most significant portion consists of consumers engaging in a legitimate transaction with sellers who do not report the transactions and consequently do not pay taxes (the so-called ‘passive shadow economy’).
Levels of shadow economy vary significantly across Europe, with a particularly high degree in Central and Eastern Europe. In a recent study by EY, commissioned by Mastercard, the passive shadow economy is estimated between 9% and 21% of GDP in Central and Eastern European countries. EY also calculated that as a consequence, the government of Slovakia lost revenues of about 2.7% of GDP in 2014, and Poland about 2%.
Electronic payments shed light on the shadow
Cash payments are the principle enabler of the shadow economy and a key factor in VAT avoidance. Cash transactions are untraceable and easier to hide from tax authorities.
The solution? Moving away from cash, and encouraging electronic forms of payment.
Policymakers are increasingly aware of the benefits of curbing cash. Dutch MEP Cora Van Nieuwenhuizen recently said, “The number of financial transactions which are unknown to tax authorities has to decrease drastically and there is a concrete way to make this happen: the facilitation and promotion of electronic payments. One of the many advantages of paying electronically is that it is traceable and there is proof of the transaction.”
However, the reality is that the move from cash to electronic payments is happening slowly. It is a fact that governments that took measures to facilitate the use of electronic payments have seen their tax revenue increase. According to EY, doubling the value of electronic payments should lead to a reduction of the shadow economy up to 3.7% of GDP and an increase in government revenues of up to 0.8% of GDP.
Moving to a cashless society is a gradual process that requires balanced policy measures which are a combination of incentives and obligations.
First of all, the development of payment infrastructure (terminalisation) is imperative.
For instance, in an effort to support accessibility and modernize payments infrastructure in rural areas, the Romanian government adopted a bill that regulates cash-back at the point of sale and obliges merchants to install a terminal as of a certain turnover threshold.
Merchants however only represent one side of the story. Governments manage millions of payments every day such as taxes, invoices, etc. Promoting government acceptance is therefore critical.
In Italy, millions of citizens can now pay their tax and utility bills faster and more easily because the government enabled acceptance of electronic payments at nearly 70,000 new locations and more than 100,000 points of sale nationwide.
Once the infrastructure is there, it is equally important to change consumer and merchant behaviour. Examples of this were the recent campaigns launched in Romania, Bulgaria and Croatia to leverage lotteries to drive card usage.
There are many other concrete examples that governments can follow to fight the shadow economy and build a more sustainable and transparent tax collection system. As illustrated above, the total payment value chain needs to be targeted and measures should range from strengthening payment infrastructures, encouraging merchant and government acceptance and incentivising consumer use.
While the results of the European Commission’s VAT Gap Study reminds us how important the fight against tax evasion is, best practices in Europe show that policymakers can make a difference by adopting the right policy solutions.
 Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Poland, Serbia, Slovakia and Slovenia.