ICSW

Oxfam, the renowned British relief agency, estimated last year that developing countries are losing at least US$ 50 billion every year as a result of tax evasion, international competition to provide tax relief, and damaging tax practices . This is six times the amount needed to provide all the children of the world with a basic education, and three times the amount that would be needed to provide basic health care in all developing countries.

What is euphemistically referred to as “tax optimisation” is in reality a major obstacle in the effort to combat poverty and further human development.

Ruinous Competition

International tax competition is becoming more intense as a result of economic liberalisation and globalisation. While every country pays a price for this, the effect on developing countries is especially severe. In order to attract foreign direct investment, these countries offer multinational companies increasingly lower taxes on profits and other privileges, in an attempt to become more attractive than other locations. The result is a downward spiral of ruinous competition. The rates for taxes on profits paid by US multinational companies operating in the South dropped by about half, from an average of 54% to 28%, between 1983 and 1996.

This has disastrous consequences for the national treasury in the countries affected. According to the World Investment Report of UNCTAD, the UN trade organisation, total foreign direct investment in developing countries amounted to US$ 1,219 billion in 1998. Assuming realistic average profits of 20%, this level of investment would produce an approximate return of US$ 244 billion. If all developing countries levied taxes on profits at the rate that is normal in OECD countries, an average of 35%, tax revenues would amount to around US$ 85 billion. In reality, developing countries collect only US$ 50 billion. Oxfam thus estimates that these countries lose US$ 35 billion as a result of intensified international tax competition.

Capital Flight to Tax Havens

In recent years, there has been a worldwide shift from taxation of capital to taxation of labour, consumption (value added taxes) and withholding taxes (social security contributions). Taxes on corporate profits and high incomes have dropped, while taxes on consumption and withholding taxes have risen, sometimes dramatically. The rich have been the main beneficiaries, as taxes on consumption place a relatively higher burden on low incomes. These developments have taken place not only in industrialised countries but also in the South.

Taxes usually account for a considerably lower proportion of GDP in developing countries than in industrialised countries. In addition, the rich avoid taxation on income and assets in their home countries whenever possible by moving capital abroad. By 1990, Oxfam estimated that capital flight from developing countries amounted to about US$ 700 billion, and calculated that the countries affected lose US$ 15 billion in tax revenues. Oxfam’s calculations are made as follows: an average return of 10% is assumed on US$ 700 billion. This results in taxable income of US$ 70 billion. Assuming a tax rate of 22%, the tax revenues would amount to approximately US$ 15 billion. When this amount is added to the losses resulting from competition among tax havens, developing countries lose a total of US$ 50 billion in potential income.

The Threat from “Fiscal Termites”

Various international organisations including the UN, OECD, and World Bank have set a goal of cutting absolute poverty in half by the year 2015. But this goal can only be attained if tax evasion and tax dumping are curtailed. If effective countermeasures are not taken, countries in the North as well as the South will become even less able to secure the resources needed to finance public expenditures and make necessary investments in education, health care and infrastructure.

Vito Tanzi, who was director of the Fiscal Affairs Department of the IMF until January 2001, refers to “fiscal termites” when describing the problems of tax evasion and tax dumping. According to Tanzi, “These termites are part of the evolving ‘ecosystem’ of globalisation, and whether they will eventually severely damage the fiscal houses remains to be seen”. Tanzi uses the term “fiscal termites” to refer to e-commerce, electronic money such as credit cards, intra-company trade, and especially offshore financial centres, derivatives and hedge funds that continue to make it easier for companies and individuals to evade taxes. Tanzi concludes that it will be necessary to find new ways of raising tax revenues.

International Efforts to Combat Tax Evasion

Offshore centres with their dubious offers and practices are making headlines, and are becoming an increasingly important issue in international politics (see pg.11). Numerous international bodies are active in the fight against tax evasion. However, the reality often falls far short of the intent and not all problems are fought with the same resolve. Various initiatives have been launched, and countless committees have been formed. Yet developing countries, while hard hit by tax evasion, are either completely excluded or severely under-represented in these initiatives.

The Battle Against Money Laundering

In previous years, international efforts have been focused primarily on the battle against money laundering. More recently, combating terrorist financing has become the predominant issue. Virtually all countries as well as many international organisations claim to be committed to combating the scorned practice of laundering dirty money, yet there continues to be a huge gap between intent and action.

Against this backdrop, the IMF has drawn up measures to combat money laundering. The IMF measures are designed to take effect when money laundering affects macro-economic stability, within the framework of its normal supervisory functions, and by providing technical assistance to member countries. The UN is also helping to combat money laundering, through for example its campaign against drugs and corruption.

The most active body is the Financial Action Task Force on Money Laundering (FATF). Founded at the instigation of the seven main industrial countries (G-7), this Paris-based task force has issued 40 recommendations. In February 2000, it published a list of 15 countries or territories whose conduct was deemed non-cooperative in the international fight against money laundering. These countries face the threat of international sanctions if they do not take appropriate action soon. Financial transactions with these countries could be subject to conditions, or even banned completely.

Other Efforts on the Fiscal Front

The European Union (EU) wants to establish a new and effective system of taxing cross-border interest payments made to individuals within the Community. Each member state will ultimately be expected to provide information to other members on interest paid. The EU is negotiating similar agreements with important non-member states such as Switzerland and with small offshore centres.

Until now, Switzerland has resisted negotiating its policy of bank secrecy, and maintains that they will be unable to inform tax authorities about interest paid to individuals. However, Switzerland has offered to increase its withholding tax of 35% and to pay 20% of these taxes to member states of the EU. The EU needs to find similar solutions for smaller offshore centres. It is also important that similar solutions are found for developing countries.

The OECD Fiscal Committee published a report in April 2000 on improving access to bank information for tax purposes pursuant to a specific request made by a tax authority. Switzerland and Luxembourg fought bitterly against this move. Against the will of most OECD countries, both countries successfully insisted that criminal liability must also be applicable in the country or jurisdiction where application for legal assistance is made.

An OECD working group on harmful tax practices published a report with 19 recommendations. Again Switzerland and Luxembourg stated their reservations, claiming that the report only looked at taxation of financial transactions but did not take into account either subsidies or other tax incentives. The US supported Luxembourg and Switzerland in their position. President Bush, who wants to significantly reduce the tax burdens imposed by the US on the rich, regards the OECD’s activities against tax evasion as excessive. He endorses international tax competition and is therefore prepared to tolerate tax loopholes in offshore centres – much to the delight of the international business world.

Development Policy Requirements

From a development policy perspective, all efforts that mitigate the negative impact of offshore centres need to be increased. However, the measures implemented to date are unbalanced. Industrialised countries focus much more on money laundering than on tax dumping. And they concentrate primarily on harmful practices in small, dependent offshore centres while discreetly turning a blind eye to their own offshore practices.
Some of the main requirements from a development policy perspective are as follows:

developing countries must be allowed to co-operate in international measures so that they are able to incorporate their own
interests;
multinational companies should be subject to a global-standard tax basis;
tax evasion must be fought multilaterally on the basis of common standards;
a global fiscal authority should be set up to examine national tax systems and identify negative global influences;
an international convention must be established to trace and recover assets that have been illegally siphoned off;
smaller, dependent tax havens should be offered technical and financial support to wean their national economies off their reliance on harmful practices; and
mutual exchange of information among tax authorities must be increased.

In mid-October 2001, international experts met to discuss these questions and agreed on further mutual collaboration. Several of these proposals have been submitted to the process for the International Conference on Financing for Development, being held in March 2002 in Monterrey, Mexico.

Bruno Gurtner is Senior Economist with the Swiss Coalition of Development Organisations.
P.O. Box 6735, Berne, Switzerland. Phone: +41 31 390 93 35. Fax: +41 31 309 93 31
Email: bgurtner@swisscoalition.ch

1- Oxfam (2000) Tax Havens: Releasing the Hidden Billions for Poverty Eradication. Oxford, 2000 (www.oxfam.org)

2- Tanzi, Vito (March 2001) “Globalisation and the Work of Fiscal Termites” in Finance & Development: A Quarterly Magazine of the IMF, Volume 38, Number 1. (www.imf.org)