Jenny Kimmis,
OXFAM GB

The Financing for Development agenda encompasses a very wide range of issues that impact on the availability of resources to finance sustainable economic growth in developing countries.

Tax Competition and Tax Havens

The globalization of capital markets has massively increased the scope for offshore activity. It is estimated that the equivalent of one-third of total global GDP is now held in financial havens. Much of this money is undisclosed and untaxed - and the rest is under-taxed. Governments everywhere have become increasingly concerned by the implications. But if governments in rich countries see tax havens as a threat to their capacity to finance basic services, how much more serious are the threats facing poor countries?

It is impossible to calculate the financial losses to developing countries associated with offshore activity. In a report published earlier this year, Oxfam estimated that tax havens have contributed to annual revenue losses for developing countries of at least US$50 billion. To put this figure in context, it is roughly equivalent to annual aid flows to developing countries. And this estimate was a conservative one. It is derived from the effects of tax competition and the non-payment of tax on capital flight. It does not take into account outright tax evasion, corporate practices such as transfer pricing, or the use of havens to under-report profit. There are three major ways in which offshore centres undermine the capacity of poor countries to finance sustainable development.

First, through tax competition and tax escape.

Tax havens, and tax competition in general, can provide big business and wealthy individuals with opportunities to escape their tax obligations. This limits the capacity of countries to raise revenue through taxation on both their own residents and foreign owned capital. Tax competition and the implied threat of relocation has forced developing countries to progressively lower corporate tax rates on foreign investors. Ten years ago, these rates were typically in the range of 30 to 35% – broadly equivalent to the prevailing rate in most OECD countries. Today, few developing countries apply corporate tax rates in excess of 20%. Tax competition also extends to efforts to attract foreign portfolio investment. Earlier this year, India was forced to reverse efforts to clamp down on the use of tax havens by foreign institutional investors for channelling funds into the country for fear that future foreign investment would stay away.

Second, the offshore system has contributed to the rising incidence of financial crises.

Tax havens and offshore financial centres are now considered to be central to the operation of global financial markets. Havens and OFCs are used by foreign exchange traders as well as by globally active private financial institutions, such as banks and investment funds, that use them as booking centres for short-term and speculative investment in developing and transition economies. Routing investment via the offshore system can be used to avoid regulation (for example, disclosure requirements), to side-step a country’s capital controls, or to reduce the levels of tax paid on profits. Currency instability and rapid surges and reversals of capital flows around the world became defining features of the global financial system during the 1990s. The crises in Mexico in 1995, and more recently in East Asia, have shown how costly such crises can be both in economic terms and in terms of human development.

Third, the offshore world provides a safe haven for the proceeds of political corruption, illicit arms dealing, illegal diamond trafficking, and the global drug trade.

Havens facilitate the plunder of public funds by corrupt elites in poor countries, which can represent a major barrier to economic and social development. It has been estimated that around US$55 billion was looted from Nigerian public funds during the Abacha regime. To put this figure in perspective, the country is today blighted by an external debt burden of US$31 billion. Northern governments justifiably press southern governments to adopt more accountable and transparent budget systems, but then create incentives for corruption by failing to deal effectively with tax havens and other tax loopholes.

Widespread concern about the offshore problem has given rise to a number of international initiatives. The OECD has taken the lead in an initiative to crack down on harmful tax competition, UN agencies are working on curbing money laundering, and the recently-created Financial Stability Forum is looking at the impact of the offshore system on global financial stability. These initiatives are useful up to a point, but they primarily reflect the concerns of Northern governments. They lack a development perspective and can also be accused of being unbalanced. The issue of financial havens goes beyond the ‘offshore’ activity of small island states to ‘onshore’ activity in major economies such as the City of London and New York.

The international community needs to adopt a more global approach to the issue of offshore finance. Oxfam believes that such an approach should incorporate the following: a poverty perspective; a genuinely inclusive approach fully involving developing countries in discussions; a multilateral approach to what are truly global problems; and strategies to help small, poor, and vulnerable economies to diversify away from a reliance on harmful tax practices. There is a range of policy options that could help countries stem tax escape, address money laundering and corruption, and foster a more stable economic environment:

1. A multilateral agreement to share information on tax matters would help countries, especially poorer ones, to stem tax evasion and illicit activities. Under such an agreement, states would agree to use their normal administrative and legal powers to obtain and exchange the information necessary to prevent international tax avoidance and to ensure that the proper tax has been paid to each country. Information sharing arrangements are the way the current debate is going – it is essential that such agreements involve as many countries as possible.

2. The international community should also support the proposal for an International Convention to facilitate the recovery and repatriation of funds illegally appropriated from national treasuries of poor countries. An International Convention of this kind would help countries like Nigeria that often come up against the brick wall of tight bank secrecy laws in Europe in their efforts to recover funds looted and kept abroad.

3. The international community could agree to allow states to tax multinationals on a global unitary basis, with appropriate mechanisms to allocate tax revenues internationally. A major problem for governments taxing TNCs is how to deal with corporations that use transfer pricing in order to under-report profits and reduce their tax liabilities. Under the global unitary approach, governments would require TNCs to calculate the accounts of their local subsidiary as a proportion of the unified accounts of the group as a whole. This would eliminate the internal transactions among related subsidiaries of TNCs, making it far easier to ensure that all profit is taxable somewhere. A formula allocation of profit could then allocate total global profits among the various parts of the company on the basis of where economic activity takes place (for example, based on the value of assets, sales, or employment in each country).

4. A global tax authority could be set up with the prime objective of ensuring that national tax systems do not have negative global implications. In the first instance a Global Tax Authority could focus on information gathering, be a forum for discussion on international issues related to tax policy, use peer pressure to bring tax free-riders into line, and develop best practices and codes of conduct on tax related issues. If sufficient trust were built up over time its mandate could increase to include the development of mandatory regulations and formal surveillance.

OXFAM has published a full examination of the issue in its policy paper: Tax Havens: Releasing the hidden billions for poverty eradication. This paper is available at http://www.oxfam.org.uk/policy/papers/taxhvn/tax.htm or from OXFAM GB, 274 Banbury Road, Oxford, OX2 7DZ, England.