Tackling Capital Flight and Tax Evasion

TRANSNATIONAL INSTITUTE Amsterdam, Netherlands April 2007 THE LONG AND WINDING ROAD: TACKLING CAPITAL FLIGHT AND TAX EVASION John Christensen1 tax justice network 1. Introduction Financial liberalisation in the late 1970s and 80s greatly increased the opportunities for capital flight and tax evasion. It led to a rapid growth in the volume of personal assets held offshore and largely untaxed, and stimulated a massive increase in the volume of cross-border trade routed via tax havens for tax minimisation purposes. Despite the plethora of international initiatives ostensibly targeted against the use of tax havens, almost all expert opinion agrees that the scale of activities conducted through tax havens and offshore financial centres2 continues to grow. A major feature of tax havens and offshore financial centres is the secrecy space they provide, either in the form of banking secrecy laws, or through de facto judicial arrangements and 1 John Christensen directs the International Secretariat of the Tax Justice Network - www.taxjustice.net 2 An offshore financial centre is defined by the IMF as a country or jurisdiction that provides financial services to non-residents on a scale that is incommensurate with the size and financing of its domestic economy. Source: Zoromé, A., (2007) Concept of Offshore Financial Centers: In Search of an Operational Definition, IMF Working Paper WP/07/87 1 banking practices. This ‘secrecy space’3 provides an enabling environment for illicit and illegal activities, facilitating fraud, embezzlement, bribery, insider-trading, market-rigging, and tax evasion, amongst other crimes. The World Bank cites estimates of the volume of cross-border dirty money4 flows ranging between one and $1.6 trillion per year, half of which originates from developing countries and economies in transition.5 The tax losses from the capital illicitly accumulated offshore would more than pay for the funding of the UN Millennium Project’s global poverty alleviation goals. In the case of Africa, which is typically portrayed as being in desperate need of capital resources, the African Union estimates that $148 billion leaves the continent every year.6 Most analysts agree that the outflows of African capital tend to be permanent, indicating that between 80 to 90 per cent of these flows remain outside the Continent.7 Thus despite its massive external debt burden, Sub-Saharan Africa is a net creditor to the rest of the world in the sense that its external assets (the stock of privately held flight capital) exceeds external liabilities (the stock of external debt, largely held by or guaranteed by governments).8 Multilateral and regional initiatives to counter capital flight and tax evasion have been limited in their scope and in some instances fundamentally flawed. This paper provides a rapid tour d’horizon of some of the more prominent initiatives, and also considers recent proposals, including some originating from civil society groups, to tackle the issues. Section 2 considers the OECD’s process for tackling tax evasion and outlines why, almost a decade after its inception, tax evasion remains a major issue even for OECD countries. Section 3 considers the European Commission’s anti-tax evasion initiative, which represents a major step forward in that it has introduced the principle of international tax cooperation through automatic exchange of tax information. However, the Savings Tax Directive in the form adopted by the EU in 2003 contains major loopholes which are being widely exploited. Section 4 explores the case for creating a truly global and representative institutional framework for tax cooperation. It notes the recent UN initiative to elevate the role of its Committee of Experts on International Cooperation in Tax Matters, but also outlines the limitations of that Committee in its current form. Section 5 looks at the recent work of the Leading Group on Solidarity Levies to Fund Development, which, in the context of the Monterrey Consensus on identifying initiatives to 3 Hampton, M.P. (1996) The Offshore Interface, MacMillan, Basingstoke 4 Dirty money is money that has been obtained, transferred or used in an illicit way. 5 World Bank Unveils Stolen Asset Recovery Initiative accessed 18 April 2007 from: http://web.worldbank.org/WBSITE/EXTERNAL/NEWS/0,,contentMDK:21299829~menuPK:51062075~pageP K:34370~piPK:34424~theSitePK:4607,00.html 6 UK Africa All Party Parliamentary Group (2006) The Other Side of the Coin: The UK and Corruption in Africa (p14) 7 Raymond Baker from the Center for International Policy, Washington, quoted from oral evidence given to the UK Africa All Party Parliamentary Group in January 2006 8 Boyce, J.K. and Ndikumana, L. (2005) Africa’s Debt: Who Owes Whom? In Epstein, G.A.(ed) Capital Flight and Capital Controls in Developing Countries, Edward Elgar, Cheltenham, UK 2 finance development, is bringing together an inter-governmental task force to spearhead new ways to tackle capital flight and tax evasion. Section 6 considers how the global dialogue on tackling corruption needs to shift towards the role of the enablers –- including the offshore financial centres and tax havens – and explores possible ways in which the UN Convention Against Corruption might be interpreted to support efforts to tackle capital flight and tax evasion. This section also briefly examines the Stop Tax Haven Abuse Act introduced to the US Senate in February 2007. Section 7 explores a civil society proposal for a new international financial reporting standard for country-by-country reporting by multinational companies. This would greatly improve the quality and transparency of tax reporting, and could radically transform the ability of national tax authorities, especially those in developing countries, to tackle trade mispricing abuses. 2. The OECD process The publication in 1998 of the Organisation for Economic Cooperation and Development’s seminal report on Harmful Tax Competition: An Emerging Global Issue, sent shock waves through the international tax avoidance industry and the community of small island tax havens. The report stimulated debate about the possibility that tax competition can have adverse macroeconomic impacts, and emphasised how abusive tax practices distort global markets and undermine development. Tax havens had already been criticised by the Financial Action Task Force for facilitating money laundering, and scrutiny intensified in 1999 when the Financial Stability Forum identified the huge volume of private assets held offshore as a potential source of global financial instability. In the 1998 report and its various successors, the OECD outlined its proposals for tackling capital flight and tax evasion by requiring the jurisdictions identified as tax havens to: • implement measures relating to registration and disclosure of information about beneficial ownership of companies, foundations, trusts and other legal entities; • agree to cooperate with requests from third party countries to exchange information relevant to criminal and civil tax matters. The OECD proposals have lost momentum, however, in the face of strong resistance from the tax haven community, from banks in OECD and non-OECD countries, and from US-based organisations9, and from other factors: First -- and crucially -- the OECD proposals were restricted in geographical scope to tax evasion by corporate and individual residents of OECD countries. The OECD also restricted its list of tax havens to 38 jurisdictions, mostly small island tax havens, and excluded major tax haven jurisdictions like Luxembourg, Switzerland, the United Kingdom and the United States. The smaller (and often relatively poorer) tax havens in the Caribbean and elsewhere raised a storm of protest about this discrimination, and their demands for a more level playing field stalled the process. (The OECD tax havens were quite happy to ally themselves with the 38 identified 9 Most noticeably the Centre for Freedom and Prosperity - www.freedomandprosperity.org 3 tax havens to undermine the whole process.) They were supported by groups in the US, notably the Coalition for Tax Competition, which in 2004 called on Republican members of the US Senate to threaten withdrawal of US funding for the OECD. Second, the OECD proposals opted not for automatic exchange of information, but for information exchange on request, which is far weaker, more expensive and difficult to operate, and consequently less likely to deter tax evasion. Applications for information must demonstrate a ‘foreseeable relevance’ for tax compliance, which means applicant countries need to provide evidence to back their requests, and cannot simply embark on ‘fishing trips’ for information. OECD officials claim that the ‘on request’ approach involves no compliance costs for participating businesses, while automatic exchange requires some extra cost (in practice this is unlikely to be significant.) OECD documents confirm that the ‘on request’ approach is particularly problematic for developing countries, which have far less capacity to pursue enquiries through unwilling foreign courts10 in tax havens. By 2005 the OECD’s process was effectively stalled. At the November 2005 meeting of the OECD Global Forum on Taxation in Melbourne the OECD abandoned the time periods it had imposed on tax havens to comply with its transparency and information exchange requirements. This was a major retreat, effectively transforming the OECD proposals into relatively toothless voluntary codes of conduct. Some progress has been recorded

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