Bridging the Gap: Unveiling the Potential of Tanzania’s SMEs through VAT Insights

Abstract The collection of value added tax (VAT) is essential for achieving domestic revenue objectives, yet VAT gap estimation is rarely performed in developing countries. This study utilizes innovative tax declaration and audit data to estimate VAT misreporting in Tanzania, applying a machine learning approach to predict evasion in unaudited firms and periods. We measure the underreporting component of the compliance gap, quantifying potential revenue losses due to inaccurate reporting. Our findings indicate that firms often avoid excessive audits, leading to increased evasion, with those firms showing the largest VAT gaps. We estimate a 62% VAT gap among small and medium-sized enterprises in Tanzania. Finally, we present a cost-benefit ratio, suggesting that while auditing sectors with large VAT gaps is cost-effective, those contributing significantly to the overall VAT gap should also be prioritized for revenue generation. (JEL codes: H25, H26, and H32)