Plug tax loopholes before fighting illegal financial flows

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Plug tax loopholes before fighting illegal financial flows

Plug tax loopholes before fighting illegal financial flows
Photo credit: Carly Learson | UNDP Liberia

Efforts to raise revenue for investment in development projects should focus first on capturing the billions of dollars hidden from tax authorities through legal maneuvers, experts say.

Stemming the legal transfer of wealth out of the world’s poorer countries is one of the most effective ways to help their governments raise the additional revenue needed to improve services such as education, health, energy and transport, a panel of experts said on 5 June during a high-level discussion in Geneva.

The comments came during the annual meeting of UNCTAD’s governing body, the Trade and Development Board, and the experts were addressing the issue of plugging financial leakages to help fill the trillion-dollar investment gap that developing countries face to fund the projects associated with the UN-endorsed 17 Sustainable Development Goals (SDGs).

“We know that the ambitious Sustainable Development Goals can only be achieved if we manage to mobilize national and international resources, which is far from the case currently,” UNCTAD Deputy Secretary-General Isabelle Durant said in her opening statement.

“One of the best ways of raising these resources is to plug the many financial leakages that have allowed inequalities to persist and indeed grow deeper between and within countries,” she added.

But as the speakers noted, the financial flows stripping government coffers are both illegal, such as criminal funds related to drugs, racketeering and terrorism, and legal, such as tax avoidance and the wealth stashed in offshore tax havens.

And the legal part of the pie may be the bigger and easier to combat.

According to the background note that UNCTAD prepared for the discussion, of the hundreds of billions of dollars thought to be hidden from governments, an estimated two thirds relate to cross-border tax-related transactions.

Coming forward

Daniel Titelman, director of the development division of the UN Economic Commission for Latin America and the Caribbean, said that although governments and international organizations should fight illicit and licit leakages, they may have more statistical and policy tools to stem the legal flows, particularly tax avoidance.

“That’s very important because when you have to finance long-term expenditures like the SDGs you need permanent income,” Mr. Titelman said. “And permanent incomes are related to the tax base.”

To illustrate the effect this could have, he cited the experience Latin America had two years ago when it offered amnesty to those who voluntarily declared financial assets they had kept under the radar.

In Argentina, he said, the undeclared assets put on the table amounted to around 21% of GDP. And the fines paid by those who came forward was worth about 2% of GDP – an amount that would have been very difficult to raise through tax reform.

“It can take you two years of debate to pass a tax reform to try to raise the same amount,” he told governments in attendance.

Good but not enough

But for Ambassador Courtenay Rattray, Jamaica’s permanent representative to the United Nations in New York, long-term results will depend more on international action.

“Domestic actions are not sufficient because of the cross-border nature [of the financial flows],” Mr. Rattray said.

And statistics back him up.

In the case of Argentina, 80% of the undeclared financial assets had been hidden abroad. According to United Nations estimates, around 22% of Latin America’s financial wealth – about $21 billion – is kept in tax havens. For Africa, it’s around 30%, or $14 billion.

“I think we can agree that wealthy individuals should pay their fair share and not be allowed to hide wealth behind veils of financial secrecy,” Mr. Rattray said.

“And as agreed in the Addis Ababa Action Agenda, profit should be taxed where economic activity occurs and where value is created,” he said, referring to the global agenda to raise financial resources to fund development.

He added: “There is no longer any excuse for jurisdictions to turn a blind eye to the enablers of international financial flows – the so-called professionals that ignore the illicit nature of the wealth that they are managing and profiting from. We need to end the operation of jurisdiction secrecy, and the authorities in these safe havens should step up prosecution of the enablers to provide a real deterrent to this type of activity.”

Just playing by the rules

The discussion’s moderator, Jayati Ghosh, a professor at New Delhi’s Jawaharlal Nehru University, agreed that the real problem is that the rules allow wealthy companies and individuals to play the system.

“All of these [maneuvers] are actually legal in various jurisdictions,” she said.

The speakers agreed that what is needed, therefore, is international tax cooperation.

Ms. Ghosh said an interesting proposal to combat tax avoidance by global companies is being developed by the Independent Commission for the Reform of International Corporate Taxation.

The idea, she said, would be to treat multinational corporations and their subsidiaries as a single entity for tax purposes and allocate their worldwide profits according to an agreed-upon formula.

“Now, obviously this requires some consensus on a minimum tax rate, but it would in one stroke eliminate basically erosion and profit shifting,” she said, claiming that these two strategies used by companies were “possibly the largest single means of licit tax avoidance”.

“This proposal is essentially something that seems ambitious but possibly may not be all that difficult if there is sufficient political will among the developing countries,” she added, saying that the European Union’s proposal for a common corporate tax rate was already a step in the right direction.