Mind the Gap! The (unexpected) impact of COVID-19 pandemic on VAT revenue in Italy

The decline in VAT revenue during the Covid-19 recession has been unexpectedly lower than the drop in household consumption. In the first half of 2021, VAT bounced back to pre-crisis levels even though aggregate consumption had still not recovered. According to our analysis, this result reflected the peculiar nature of the pandemic crisis and the subsequent shutdown of retail shops and services, which has considerably affected consumer habits. Consumption of services, characterized by lower VAT rates and a lower degree of compliance, dropped massively, while spending on durable goods fell briefly at the onset of the crisis and then rose quickly to pre-crisis levels; moreover, the share of cashless payments has increased, both in physical stores and on-line. If the change in payment habits turned out to be permanent, this would lead to a structural reduction in the government deficit. Additionally, we provide preliminary evidence on the effect of electronic payments on reducing VAT tax evasion: a one-percentage point increase in the share of cashless payments results in approximately 0.4 per cent higher VAT revenue owing to increased compliance.