ILLICIT FINANCIAL FLOWS AFFECTING NATIONS:
CAPITAL flight, financial crime, corruption, and tax evasion have a major negative impact on countries around the world. According to recent studies, crime, corruption and tax evasion drained close to $1 trillion from developing countries in 2011 alone. Illicit financial flows were estimated at $5,9 trillion between 2011-2002, according to a 2013 report by Global Financial Integrity (GFI).
As the GFI report notes, “illicit financial flows are the most devastating economic issue impacting the global South.” Alarmingly, such flows are increasing, up 10 percent per year over the past decade.
Furthermore, north of $20 trillion is estimated to be held by high net worth individuals and corporations in offshore havens worldwide, according to a report by the Tax Justice Network (TJN). The OECDs Financial Action Task Force (FATF) meanwhile estimates $1,5 trillion is laundered globally every year.
Most of these trillions, whether legal or illegal have passed through, or been handled by, the Western financial sector and offshore tax havens. The City of London, for instance, accounts for 11 percent of the world’s banking.
While the Western financial system benefits from such in-flows of cash, so do tax havens. Tax havens or “paradises” are typically politically stable jurisdictions that attract business to enable individuals and entities to circumvent the rules, laws and regulations of other jurisdictions.
On average, the GFI found that offshore centres accounted for 43,9 percent of illicit out flows from Asia, 36 percent from the Middle East and North Africa (MENA), 26,8 percent from Africa, 15,8 percent from Europe, and 10,4 percent from the Western Hemisphere.
However, since the recent financial crisis, governments have begun to tackle tax evasion to reduce national debt. In July 2014, the United States introduced the Foreign Account Tax Compliance Act (FATCA), which seeks to curb tax evasion by American citizens with bank accounts overseas. In addition, the US and European Union have cracked down on Switzerland as a tax and bank secrecy haven.
In September 2014, the Organisation for Economic Co-operation and Development (OECD) launched a tax-sharing plan endorsed by 44 countries, including all OECD members and the Group of twenty (G20) nations. This initiative seeks to “eliminate double non-taxation or hybrid mismatching (where a company uses treaty arrangements to avoid paying tax in two jurisdictions), to establish multilateral tax agreements to streamline international tax rules (as opposed to the current system of more than 3 000 bilateral agreements), and create a standard for companies to report their activities and profits in each jurisdiction where they operate”.
Such steps, if enacted and enforced, would not only rein in tax havens in the Caribbean states of Jersey and Guernsey, but also in the US and Britain, which are the world’s two largest tax havens. If successful, the OECD initiative could have positive ripple effects worldwide by bolstering transparency and by reducing tax evasion and illicit capital flight from less developed economies. While external initiatives are important, countries will have to improve national fiscal and taxation policies as well.
International experience in addressing capital flight
Reducing capital fight is essential as it would reduce dependency on foreign aid and FDI, which can lead to a vicious cycle of debt-repayment and further capital out flows. Retaining capital would open up funds for the development of, for instance, small and medium-sized enterprises (SMEs), which are key to strong and diversified economies. With less capital out flow, more tax revenues would also be available for public infrastructure projects and services. Moreover, reducing illicit out flows would result in other socio-economic benefits, such as reducing crime, corruption, money laundering, and tax evasion.
Experience has shown that more support and funding is needed for institutions and organisations to address the causes of capital flight by expanding economic programs currently in place, and by carrying out surveys and research into what citizens and economies need to thrive.
A number of countries, for example, MENA, OECD and developed economies, in particular, have come up with regulations and guidelines for tackling financial crime and money laundering Members in MENA and OECD have come up with Financial Action Task Force (FATF) regional body MENA-FATF with a view of tackling illicit financial flows. However, enforcement of such laws is weak, and more public-private co-operation is needed to reduce illicit crimes.
Lessons drawn from this observations are that in order to tackle illicit financial flows there is need for robust fiscal policy which is transparent and fosters public confidence.
On the tax and trade level, Governments are considering restructuring tariffs on imports and comprehensive sales taxes to raise tax collection on the one hand, while on the other hand lowering tax evasion, smuggling and trade mis-invoicing. Import monopolies and trade oligopolies were identified to be one of the key facilitators of illicit financial flows and as such countries are encouraged to open their economies for more players or address the monopoly situation via taxes.
Major disparities in taxation rates across the region contribute to tax evasion within the MENA.
Other necessary policies will be equally hard to implement, but necessary for longterm economic sustainability. MENA countries, for instance, need more policy space to develop policies that are more applicable to their economies with regard to free trade, namely protectionism, foreign investment regulation, and intellectual property rights. These are all policies that developed countries initially used to advance their economies but in the case of the MENA they have been externally imposed without taking into consideration the specific local contexts. Applying economic policies suited to the region would provide more incentives for capital to stay within MENA countries.
At a global level, there is consensus that reforms are needed in the financial and regulatory system as well as in international bodies such as the World Trade Organisation, the World Bank, the International Monetary Fund, and the Bank for International Settlements. While such reform is needed internationally, further domestic reforms at the political and economic level is required in the MENA.
While these recommendations aimed at tackling illicit financial flows are sound and good, at a country level, there is need for research aimed at understanding the scale of capital flight, separating the legal and illegal ones, identify structural and institutional characteristics that affect capital flight at a country level; and what measures are needed to monitor out flows of untaxed international trade transactions and other forms of illicit and licit or legal capital flight. This process is key to tackle capital flight in a comprehensive manner.
Asante Sana.