The VAT gap in South Africa: A bottom-up approach

Improving domestic tax revenue mobilization through increased tax compliance is imperative when policy reform options are limited. For this purpose, determining tax compliance gaps is important, but it requires detailed information. In South Africa, value-added tax is the second-largest contributor to tax revenues; however, few studies have estimated the difference between actual and potential tax revenues. This paper uses audit and value-added tax return information from the South African Revenue Service to calculate the domestic value-added tax gap. As few firms are audited on a predetermined risk basis, predicting potential discrepancies for unaudited firms is necessary. We use machine learning and address bias by including observable selection variables in the model. We find a persistent value-added tax reporting gap averaging 40.6% from 2016 to 2020, with a notable peak in 2020. The industry and regional results underscore the need for focused strategies to reduce tax evasion and enhance compliance.