Abstract

This paper utilizes an otherwise standard micro-founded general-equilibrium
setup, which is augmented with a revenue-extraction mechanism to assess the
magnitude of VAT evasion. The model is calibrated to Bulgaria after the introduction of
the currency board (1999-2014), as one of the very few countries in Europe with a nondifferentiated consumption tax rate, and an economy where VAT revenue makes almost
half of total government tax revenue. A computational experiment performed within
this setup estimates that on average, the size of evaded VAT is a bit more than one-fourth of output, an estimate which is in line with the figures provided in both Philip
(2014) and the European Commission (2014). In addition, model-based simulations
suggest that increases in spending on law and order could generate substantial welfare
gains by decreasing VAT evasion.