Dirty money, lost taxes, and the offshore industry
The Education and International Research Institute, on behalf of the Council of Global Unions has just released an important and comprehensive report into global corporate tax avoidance and evasion, and the consequences of such practices for both developed and developing nations. Below, an edited extract from Chapter 1 of that report, by Laura Figgazolo, presents various estimates of the enormous sums lost to public revenues through different techniques of tax ‘minimisation’ and the amounts involved globally in the so-called ‘offshore’ economy. She describes how multinational companies (MNCs) use their global reach to avoid their responsibility to contribute through fair and responsible taxation to national and community social needs, with harsh consequences for communities in both industrialised and developing countries.
The offshore economy
The size of the offshore economy remains difficult to measure precisely, because of its fragmented nature and blurry definition. Loss of tax may be through illegal (for example, tax evasion) or legal (tax minimisation or avoidance) means.
A considerable body of research exists on the amounts of capital involved. Considering individuals, as distinct from corporations, the Tax Justice Network published a report in 2005 based on data from Boston Consulting. McKinsey’s, Merrill Lynch/Cap Gemini and the Bank for International Settlements, estimating that the world’s so-called ‘High Net Worth Individuals’ (HNWIs) held around $11.5 trillion of assets offshore.
On rates of return applying at that time, there was a consequent tax loss of $250 billion as a result of the capital being held offshore, more than three times the OECD countries’ official development assistance to the entire world at that time. The report’s author, Richard Murphy, described this figure as “extremely conservative: it they did not include tax losses resulting from tax competition and trade mispricing... [nor]... corporations, which reportedly pass more money through tax havens than individuals.”
The above figures included both residents (for tax purposes) and non-residents. In March 2010, Global Financial Integrity (GFI) published a study estimating that current total deposits just by non-residents in offshore and secrecy jurisdictions were close to US$10 trillion, with the US, the UK and the Cayman Islands topping the list of jurisdictions (GFI, 2010a). It is estimated that 60% of all global trade is actually routed through tax havens (GFI, 2010a).
There are two types of estimates on global flows of “dirty” money. One focuses on illegal flows. The other focuses on all kinds of abusive tax practices, whether legal or illegal.
Regional picture
Professor Kimberly Clausing of Wellesley College estimated in 2009 that the U.S. Treasury lost over $60 billion in tax revenues in 2004 from profit-shifting by corporations to low-tax countries. A preliminary update in 2011 suggested that estimate should be raised to a loss of $90 billion a year in tax revenues.
Tax evasion in the EU is estimated to be 2-2.5% of total European GDP. The Bank of Italy estimates that Italians hold some 500bn in undeclared funds outside the country (Banca di Italia, 2010).
Foreign private wealth managed in Switzerland is estimated to amount to between 2500 and 4000 billion Swiss francs. In February 2010, the Geneva-based research group Helvea produced estimates of approximately 500 billion in "black money" from Europe.
In February 2009, research for the BBC's Panorama programme calculated that the UK loses about £18.5 billion per year to tax havens, including avoidance and evasion (Murphy, 2009). In February 2008, Britain's Trade Union Congress (TUC) published a report estimating that £25 billion annually is lost to the UK from tax avoidance: £13 billion per annum by individuals plus £12 billion per annum from tax avoidance from the 700 largest corporations (TUC, 2008).
Corporate taxation vs. corporate profit
MNCs use their global reach to avoid their responsibility to contribute through fair and responsible taxation to national and community social needs and public services upon which corporations themselves, their employees, and owners depend in different ways. Multinational and foreign-owned companies operate alongside national ones, but often do not pay the same levels of taxation. Multinational companies may play countries off against each other, moving, or threatening to move to countries that either have a low tax level or offer them special tax incentives, with consequent pressure on governments to reduce corporate income taxes in order to remain attractive as investment locations. This holds true, with harmful consequences, even if these countries’ need for public services and infrastructure has risen (Hall, 2010).
Taxation has thus become an instrument for attracting and maintaining capital, with most cuts in corporate tax rates within the last ten to fifteen years justified by international tax competition and the need to stay attractive to multinational capital (Morisset, 2003). But, as the advantage of such cuts in corporate tax rates is often negated by similar or further cuts in other countries, the gains of this continuous cutting are indeed short term, and they tend to lead to long term losses in all countries engaged in a race to the bottom (ICFTU, 2006).
Broadly speaking, within the last twenty years, statutory corporate tax rates have fallen by a third, from around 45% to less than 30% on average in the thirty OECD countries, and a similar development has taken place in the forty five non-OECD countries, where rates have dropped from just above 40% to a little less than 30% (ICFTU, 2006).
Between 2000 and 2005, 24 out of the 30 (in 2006) OECD countries lowered their corporate tax rates. Only 6 of them kept rates steady, and no OECD country raised its rates in that period. Major cuts took place in Austria, which cut its corporate tax rate from 34% to 25%, in Germany, from 52% to 39%, in Greece, from 40% to 32%, in Iceland, from 30% to 18%, in Ireland, from 24% to 12.5%, in Poland, from 30% to 19%, in Portugal, from 35% to 27%, and in the Slovak Republic, from 30% to 19%.
These cuts mean that average rates in all OECD countries have dropped from 33.6% in 2000 to 28.6% in 2005 (OECD Tax Database). Outside the OECD, during the same years, rates have generally fallen: in Bangladesh, from 35% to 30%, in Brazil, from 37% to 34%, in India, from 38.5% to 33.5%, in Pakistan, from 43% to 35%, in Panama, from 37% to 30%, and in Singapore, from 26% to 20%.
If we express corporate tax revenue as a proportion of GDP,in fact, (theoretical) tax revenues from corporate profits have remained at the same level since 1965, while profits have risen as a share of GDP. As a share of total tax revenue, tax revenues from corporate profits have been relatively constant since the 1980s, after a decline until 1980. However, tax competition has intensified within the last decade, with increasing mobility of multinationals and, over the last decades, some of the world’s largest economies –the US, Japan, Germany, the UK and Italy – have seen their actual revenue from corporate taxation decline substantially. These countries do not appear to have engaged too actively in tax competition (only cutting their statutory corporate tax rates moderately during this period), but are indeed the countries that have lost most public revenue from corporations.
This may suggest that real tax contribution from the corporate world to public finances and society in general is declining (in spite of a rising profit share) not just by way of reductions in statutory corporate tax rates, the upsurge in export processing zone, and the proliferation of tax havens. The basis on which corporate taxes are collected and the extent of deductions, exemptions and other loopholes enacted by governments is just as significant as the developments in tax rates, tax holidays and tax havens (ICFTU, 2006). In fact, whether through political pressures, or simply via tax evasion, the actual revenue from corporate income tax has fallen from about 4.2% of GDP in 1985 to about 2.4% of GDP in 2008.
However, over this same period, corporate profits have increased their share of GDP in the major OECD countries, so that it now represents about 35% of GDP, compared with only about 25% in the early 1980s. Yet the effective rate of tax paid has halved. If corporations were still paying at the same effective rate as in 1980, they would be contributing tax equivalent to about 5% of GDP. Instead, half of that amount of revenue is lost, and has to be found from other sources (Hall, 2010).
Transfer Pricing
Transfer pricing, in particular, plays on the fact that an estimated 40% of global commerce occurs within global corporations, enabling them to avoid national taxes by manipulating the prices charged for the transfer of goods and services. This phenomenon has developed dramatically since the mid 1990s. The technique is more easily available to global companies, than to national small or medium enterprises (SMEs). It is estimated that several trillion U.S. dollars of tax revenues are lost to national budgets annually through the use of such techniques – enough to provide the resource needs of the UN Millennium Development Goals (MDGs) and the budget requirements for social services in industrialized countries, including the growing costs associated with migration and global mobility.
Many national jurisdictions have been dealing with the matter to a greater or lesser degree. Despite well-established regulatory frameworks, however, serious problems remain.
Transactions performed in tax havens and even in some European countries pose difficulties. Another issue is the assessment of more intangible transactions – i.e. intellectual property, expertise (consulting), know-how etc. entered into by related parties. It is difficult to establish a fair market price for transactions that are not conducted between independent companies. It is complicated to untangle this web as transfer pricing is also influenced by tariff structures, exchange rate fluctuations and risk, profit repatriation policies, and asset capitalisation policies. This means that, while it is very hard to get a clear and transparent sense of what is really going on, there is ample scope for global corporations to play on the complexities to their advantage.
Implications for developing countries
In January 2009, GFI published a report on illicit flows from developing countries, estimating that, in 2006, developing countries lost $858.6 billion – 1.06 trillion in illicit financial outflows (GFI, 2009). In February 2010, GFI published another report calculating roughly that developing countries are losing $98 billion to $106 billion each year due solely to re-invoicing; approximately 4.4% of the developing world's total tax revenue (GFI, 2010b). James Henry, a former chief economist at McKinsey & Company, says that foreign aid into developing countries has been accompanied by very large outflows of private capital, producing the largest wave of capital flight in history, revolutionising at the same time the world’s offshore private banking market (Hiatt and Perkins, 2007). He has estimated the outflows resulting from such debt-flight cycle at an average of $160 billion per year (in real 2000 dollars) from 1977 to 2003. By the early 1990s, the total amount of untaxed Third World private flight wealth exceeded the value of all outstanding Third World foreign debt. In a March 2009 analysis for Oxfam, Henry found that at least $6.2 trillion of developing country wealth is held offshore by individuals, depriving developing countries of annual tax receipts for an amount of $64 to $124 billion. The scale of the losses could outweigh the $103 billion developing countries receive annually in overseas aid. Capital flight is a growing problem, too, with an additional $200-300 billion being moved offshore each year (Oxfam, 2009).
Taxation and the public good
Without taxes, there would be no civilized society, nor legal system, public administration, national defence, police and emergency services, nor public education and health, nor investment on infrastructure such as public roads or communications, nor social protection, nor adequate environmental conservation. Therefore, taxes are necessary. They are integral to the construction and maintenance of societies.
“Taxes are also used to ensure some degree of income distribution, equal opportunity and a minimum of living standards. In short, the sustainability of any modern society and economy requires the state to have sufficient revenue to fund the physical and social infrastructure essential to economic welfare, development, stability and security.” (Weise, 2006.)
Over the years, there have been different kinds of taxes – on income, consumption, trade, property and profits – and the mix has varied both over time and among countries. The design of tax systems basically depends on two considerations: what taxes should be used for, and what sources should be taxed. The debate about the sources of tax and the need to balance tax revenues with the needs of society is one of the most important ongoing political debates in democracies.
In the global economy, corporate taxation has become more of an issue internationally, although the rules and regulations which govern this and most other forms of taxation remain essentially national. Most if not all countries in the world have global corporations operating within them. This has made corporate taxation all the more tricky and complex. That being said, the need for common understandings among nation-states has grown with globalisation, and is seen most clearly with the OECD Guidelines on taxation which serve as a reference, regularly updated, for the industrialized economies. Corporate taxation is an important focus of these guidelines. Since the 1950s, however, corporations have shared less of their profits with societies though they have become more and more dependent on their functioning and quality.
Over the last three decades, corporations have allocated less and less of their profits to the communities in which they operate. Tax minimization and avoidance has been legitimised, and have been not only accepted but also promoted. Global companies play countries off against each other, moving away, or threatening to do so, from countries they believe charge them too many taxes and into those that either have a low tax level in general or offer them special tax incentives. This has put pressure on governments to reduce corporate income taxes in order to remain attractive as investment locations and sites for capital accumulation. Taxation has thus become a much used tool in attracting and maintaining capital, with most cuts in corporate tax rates within the last ten to fifteen years explained and justified by international tax competition and the need to stay attractive to multinational capital. But as the advantage of such cuts in corporate tax rates is often negated by similar or further cuts in other countries, the gains of this kind of continuous cutting are indeed short term. And what is worse, they tend to lead to long-term losses in all countries that engage in such rivalry. {jathumbnailoff}
Image top: J. Stephen Conn.