Halting tax avoidance in poor countries: Europe’s responsibility

Conference on Tax and Development

European Parliament, 9 December 2009

By Nuria Molina, EURODAD

Taxation plays a key role in shaping the distribution of benefits, as it is the basis for redistribution from those with the highest incomes to those most in need. In developed countries, government revenues raised through taxation are often in the range of 35% to 40% of GDP. According to the OECD tax revenues have fallen 0.5% of the GDP in OECD countries as a result of the crisis. In low-income countries in sub-Saharan Africa, the ratio is just over 10%.

Taxation is fundamental for development as it provides the government much-needed resources to implement development strategies and invest in equitable development. But it is not only a matter of monies. Taxation is the venue through which citizens are most intimately connected to the state and can be an important catalyst for public demands for responsiveness and accountability.

Addressing the main challenges facing developing countries in the area of taxation requires both national and global measures. I will focus on the main problems at the global level, as well as the Europe’s responsibility in ensuring tax justice at home and abroad.

Size matters:the problem in figures

According to the Global Financial Integrity, in 2006 developing countries lost an estimated $858.6 billion to $1.06 trillion in illicit financial outflows. Over two thirds of this amount is lost through tax evasion and avoidance.

This is almost ten times yearly ODA amounts (over a $100 billion).

Europe ranks second in the share of overall illicit financial flows from developing countries, accounting for almost a fifth of the total.

As a result of the global crisis, the World Bank estimates that developing countries will need to attract up to $635 billion in 2009just to maintain their existing economic and social standing ($1 trillion according to the United Nations).

Foreign direct investment is projected to fall by at least 30% in 2009. Migrant remittances to developing countries are predicted to fall by $24 billion this year. Developing country debt levels are rising once again and UNCTAD has expressed serious concerns about unsustainable debts in 49 Least Developed Countries.

The crisis has shown, once again, that excessive reliance in foreign capital flows renders developing countries even more vulnerable in the event of external shocks. It is more important than ever to implement international commitments agreed in Monterrey and Doha to enable developing countries to raise and retain domestic revenues.

Tax dodging on a massive scale

The gravest impact the present global financial system has had on the developing world is the manner in which regulatory failing, lack of transparency and the growth of tax havens, with the deliberate connivance of richer countries, has facilitated tax dodging by the international business on a massive scale, thus exacerbating poverty.

One of the most common forms of corporate tax evasion is “transfer mispricing”, where different parts of the same transnational corporation sell goods and services to each other from the developing world through tax havens at prices manipulated to lower the tax liability.

Another common form of evasion is “false invoicing”, where transactions take place between unrelated companies working in collusion with each other. Importers in the developing world will inflate the price they say they have to pay to foreign supplier so they can report lower profits and hence pay less tax. The reverse can also happen. Exports from a developing country will be deliberately undervalued on paper so the profits are once again depleted. Falsified invoicing is difficult to detect as it is often based purely on verbal agreements between the buyer and seller.

The proceeds of commercial illicit capital flows are usually lodged in developed country banks and tax havens under developed country jurisdiction. While the international community points to Southern corrupt elites as the only ones responsible, capital flight relies on financial advice and bank secrecy provided by Northern countries.

Over the past thirty years the number of offshore finance centres and secrecy jurisdictions has increased rapidly to more than 70 – more than 25 being under European jurisdictions. Today more than half of global trade occurs via tax havens even if these account just for 3% of global GDP.

G20 “crisis” measures: Job not done

The G20 claimed that “the era of banking secrecy is over” and pledged to “take action against non-cooperative jurisdictions, including tax havens”. In this area the G20 relies on the OECD, which has set a weak international standard for exchange of tax information. The OECD now claims that “no jurisdiction is currently an uncooperative tax haven” and the G20 that over half of the 87 jurisdictions which are being scrutinised have “substantially implemented” its standards.

To get these endorsements governments have only had to commit to sign twelve bilateral Tax Information Exchange Agreements. This is far too few and the model of information exchange is flawed. Obtaining information under these agreements requires governments to submit cumbersome dossiers about citizens’ suspected tax malpractices, meaning that this system is rarely used. The G20 finance ministers also recognised the limitation for developing countries of current measures, saying that different approaches would be needed, “possibly including through a multilateral instrument”. However, no progress was made at the last meeting of the G20 finance ministers in Saint Andrews.

Northern’s share of responsibility: the role of Europe and the IFIs

Poorly planned financial sector liberalisation and deregulation has restricted developing countries’ ability to increase resilience of their economies against external shocks, and to implement sustainable development strategies. In the areaof tax, the International Financial Institutions have for long pushed development countries to grant tax holidays to multinational corporations; lower tariffs; set up free trade zones; and have imposed ill-advised development agreements with multinational companies.

Moreover, recent CSO research finds that public multilateral banks, such as the European Investment Bank, and the World Bank International Finance Corporationare granting support to companies and banks using offshore tax havens. Although the EIB has approved some guidelines on preventing fraud and money laundering, this are clearly insufficient and efforts should be made to upgrade them. The IFC, however, has not adopted any public policy on offshore financial centres (OFC) and tax havens in order to ensure that its lending does not go through tax havens at the damage of domestic resources mobilization for development in developing countries.Public banks should not facilitate private tax avoidance, but they should rather promote higher standards on responsible lending, including in tax matters.

The EU Member States and the European Commission have also advocated a self-regulatory approach in past decades. While doing this, the EU has set “Policy Coherence for Development” (PCD) on the agenda, finally acknowledging that conventional ODA will fail to eradicate global poverty as long as other EU policies do harm and frustrate the achievements of Europe’s development cooperation. Yet, the PCD framework has, to a great extent, missed financial regulation as one of the fundamental pillars.In the Council Conclusions from 17th November, the EU Ministers devoted three lines to this issue by saying that EU Member States should prioritise “improving transparency and countering illicit cross-boarder flows and tax evasion recognising that these have a severe impact on domestic resource mobilisation in developing countries.”

Although this is a step in the right direction, much remains to be done. The EU must take development and poverty eradication into account when designing new instruments and approaches to financial regulation. As foreseen in the EC Communication on PCD, the EU should also systematically conduct impact assessments of its policies and actions with an impact on development. In particular, ongoing reforms of the Savings Tax Directive and European accounting standards should dramatically increase transparency and ensure that they are coherence with the objective of mobilising domestic resources in and preventing illicit flows from developing countries.

What should Europe do?

  • The EU and the Member states shouldadopt a common positiontosupport,within the G20 and the OECD, the establishmentof automatic tax-information exchange between jurisdictions based on a global agreement including all countries, instead of a piecemeal approach involving bilateral treaties, which have been shown to have limited impact and which tend to exclude developing countries. Europe must strengthen the “Savings Tax Directive” extending its coverage to all legal entities and to other sources of capital income.
  • The EU and the MemberStates should promotean international accounting standard that would require multinational companies to report their profits on a country by country basis, thus enabling authorities to obtain the necessary information for taxing them. At the European level, the EU shouldensure thatthe coming review of the European accounting standards (including the review of IFRS 6 and 8, and the TOD directive)ensures that multinational companiessubmit,in the annual reports,their accounting information on a country by country basis.
  • Europe should ensure that the EIB, the IFC and other MDBs lending to private companies operating in developing countries comply with the highest standards of responsible lending, including in tax matters. Binding financial performance standards should be urgently adopted by all these institutions.
  • Europe should ensure that the International Financial Institutions stop attaching tax conditionality in their development finance. Developing countries should be granted the necessary policy space to adopt tax systems to enhance domestic resource mobilisation and establish progressive taxation systems which ensure wealth redistribution.

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