The Parliamentary Budget Office's (PBO) given publication aims to estimate potential value-added tax (VAT) and the VAT gap (difference between potential and actual revenues) in Georgia.
A tax gap, by simple definition, is the difference between maximum theoretically collectable and actual tax receipts. Since it is impossible to have an ideally effective tax system, the existence of a tax gap is inevitable. Nevertheless, due to the importance of tax revenues, tax gap minimization is a major goal of the state.
The tax gap itself can be decomposed into several parts. The most important classification for this publication involves decomposing the tax gap into policy and compliance gaps. Specifically:
 The policy gap arises because of tax revenue deviation from its potential that results from government policy comprising tax exemptions, reliefs and zero-rates (in case of VAT). Estimating the policy gap requires determining the deviation of maximum theoretically collectable receipts under existing legislation from maximum potential receipts that could have been collected had no tax exemptions, reliefs, etc. been imposed.
 The compliance gap implies intentional and unintentional violation of the existing tax legislation by taxpayers. To calculate the compliance gap, maximum theoretically collectable receipts under existing legislation should be compared to actual receipts.
This publication utilizes the macroeconomic, top-down approach for evaluating the VAT gap and its above-mentioned components, estimating the variables of interest using total GDP as the base, combined with individual sector data from national accounts. The analyzing period consists of 10 years, from 2007 including 2016. In further detail:
• Our first goal is to determine potential VAT, for which we estimate potential VAT base using data from national accounts, as well as the tax code. Applying the 18% tax rate to the base allows us to calculate potential VAT with respect to existing legislation (also calculated with respect to maximum economic potential). This potential VAT grew continuously in the analyzing period (average growth – 7.2%) and made up GEL 3.9 billion in 2016 (GEL 2.1 billion in 2007).
• Our second goal is to select actual VAT so that the chosen indicator reflects the formation and collection of tax liabilities in the reporting year as accurately as possible. To calculate this indicator, we add VAT paid on imports to net payable VAT, which is calculated as the difference between payable and reducible VAT declared for the corresponding year. In 2007-2015 average growth of actual VAT made up 5.3%, while in 2016 it increased by GEL 1 billion at once and reached GEL 3.3 billion (GEL 1.6 billion in 2007). This jump in actual VAT was predominantly caused by an increase in VAT paid on imports, while net VAT payable on territory remained largely unchanged. As per PBO assessment, this might have been caused by the treasury code reform, which resulted in more accurate accounting and, thus, provides a clearer picture of tax flows. Precise assessment of this issue will be possible by analyzing dynamics of the following years.
• After calculating potential and actual VAT, we move on to the main part of the research, which entails estimating the VAT gap.
The results of this research show that the 1st part of the analyzing period (2007-2010) was characterized by a declining VAT gap, whereas in the 2nd part (after 2011) the gap increased substantially. The VAT gap dynamics was driven by the compliance gap, while the policy gap remained largely stable. In 2016 actual VAT increased markedly, which caused the gap to instantly decline. If this trend persists, the policy gap will be established as the main component of the VAT gap in the coming years.
Overall, in 2007-2016:
• Average VAT gap was 21.2% (11% in 2016);
• Compliance gap on average totaled 26.1% (13.8% in 2016);
• Average policy gap reached 18.6% (20.6% in 2016).
As for other indicators, C-efficiency (aka VRR, coverage of maximum potential VAT) was 60.2% in 2007-2016, while the total gap to GDP ratio amounted to 6.9% on average (5.3% in 2016).
Comparing the results to other countries, considering that not many countries have systematic experience in estimating tax gaps, it is suitable to weigh the indicators up to those of EU countries. As of 2014, the compliance gap of Georgia was better than that of three countries in the EU. As for latest data, if we compare our 2016 indicators to those of EU in 2014 (latest available for EU), Georgia's gap was better than that of twelve EU countries, as well as the average EU gap (higher than France's and lower than Portugal's).
In general, it should be noted that, taking available data and methodology specifics into consideration, it is desirable to focus analysis on the gap trend and not absolute values, while any interpretation should take into account a substantial degree of uncertainty in estimating the gap. PBO plans to update the research in the following years and will present the latest estimates of potential VAT and the VAT gap periodically.