July 5, 2013
Global Financial Integrity
Christine Clough, PMP
This article was originally published by the Diplomatic Courier.
Five years after the financial crisis hit, the G8 finally seems to be serious about addressing the issue of financial opacity and illicit outflows. During a speech at the World Economic Forum in Davos earlier this year, UK Prime Minister and current G8 Chair David Cameron outlined his agenda for the Lough Eurne Summit to focus on a special blend of ‘T’: trade, tax, and transparency. He has called for “a more serious debate” on tax compliance and fairness, including the topics of automatic exchange of tax information and abusive tax avoidance. His transparency plan weaves strands of beneficial ownership disclosure and country-by-country reporting to his “golden thread” for development. The trade outline has a similar focus on openness, but it needs some direction.
This aggressive agenda is impressive, but it falls short in its push for financial transparency, and it lacks a road map for turning these statements into coordinated action when the Summit concludes. To break the cycles of poverty and instability, the G8 Leaders need to first break the cycle of inertia and debate. Mr. Cameron should champion coordinated action on the following items in order to achieve his agenda: automatic cross-border exchange of tax information; country-by-country reporting for multi-national corporations; disclosure of beneficial ownership information for all companies; better disclosure of import and export data; and, greater enforcement of and stricter penalties for trade mispricing, abusive transfer pricing, and money laundering.
Why Financial Transparency?
Illicit financial flows and abusive transfer pricing drain developing and developed countries of tax revenue and investment, and they facilitate corruption, terrorism, and transnational crime. Our research at Global Financial Integrity estimates that developing countries alone lost an estimated $859 billion through illicit outflows in 2010. This figure is extremely conservative, because it does not include the mispricing of services or (illegal) movements of physical cash.
Individuals and corporations that evade taxes or avoid them through aggressive tax planning that abuses national tax laws undermine domestic resource mobilization and rob countries of potential investment. Research by ActionAid shows how an international beer company in Ghana and an international sugar exporter in Zambia use tiny subsidiaries in Ireland, The Netherlands, and other secrecy jurisdictions to shift hundreds of millions of dollars in profits out of the countries in which the money was actually earned. The Ghanaian and Zambian governments lost the corporate tax revenue on these profits, which means smaller budgets for critical social services for the public, but the greater percentage is that lost to the economy as a whole, money that otherwise could have supported local investment and economic growth.
Mr. Cameron has rightly pointed out that these abuses are not limited to developing countries. The economies of Greece and Cyprus also demonstrate how illicit financial flows can destabilize economies, governments, and societies in developed countries. The same shadow financial system that multinational corporations and individuals use to avoid and evade taxes also manages the proceeds of corruption, terrorism, and transnational crime. In secrecy jurisdictions it is possible for virtually anyone to setup an anonymous shell corporation, in some cases without providing proof of identity or even a name for the owner of that company. If some kind of identity is required, a paid nominee often suffices. These anonymous shell companies can legally open bank accounts and credit cards, buy property, and access the legitimate financial system in places such as New York, London, and Paris. Notorious weapons trafficker Viktor Bout used shell corporations in the U.S. to facilitate his international arms smuggling business. Current and former Arab Spring heads of state, such as Gaddafi, Ben Ali, Mubarak, and Assad are either known or alleged to have billions of dollars in cash and high-end real estate in the U.S., Britain, France, Germany, Italy, and elsewhere. A New York Times investigation revealed how Hezbollah was able to route its money through Lebanon, Canada, and the United States. And these are just a few of the cases that have come to light.
A Road Map for Meaningful Change
Mr. Cameron, to his credit, has recognized many of these issues stemming from illicit financial flows, and his ‘T’ agenda for the G8 Summit this year will, if followed, help to address this damaging situation. However, he has so far missed important opportunities to go much further, and it is unclear whether and what actions will actually result from his bold words. Mr. Cameron and his fellow G8 Leaders should consider the following proposals.
Transparency: Companies must be required to publish information on their sales, profits, taxes paid, and number of employees on a country-by-country basis. Investors, government officials and the public need this information to properly understand where and how a given company is operating, such as monitoring investment risk and detecting abusive transfer pricing. Companies already gather this information for internal use, so it is a small step to make it public. Member states should also require financial institutions to identify the true, human, “beneficial” owner of all accounts held in or passing through their jurisdiction. Foundations, trusts, and companies should be required to divulge substantive beneficial ownership information to authorities at the time of incorporation. This measure would also contribute to Mr. Cameron’s counterterrorism agenda and the G8’s work on asset recovery and anti-corruption through its Deauville Partnership with Arab Countries in Transition. The current lack of sufficient financial governance creates the space in which these nefarious actors are able to finance and profit from their crimes.
Tax: The G8 should do more than just debate the issue of tax compliance and fairness; it should set an example by agreeing to automatically exchange tax information with one another. The U.S. government now has the Foreign Account Tax Compliance Act, and the governments of the UK, France, Germany, Spain, and Italy just announced plans to share tax information automatically. Canada, Japan, Russia, and the United States should join this initiative, with developing and emerging economies being invited to join as soon as possible. This must be promoted as the new global standard of information exchange. Taxes are a vital part of any modern, democratic, stable, and prosperous society, as they share the burden of paying for public goods like defense, infrastructure, and social services.
Trade: The shadow financial system undermines free trade by creating barriers to entry and by creating unstable financial markets. Access to good information on international price norms is vital to detecting and deterring the mispricing of trade, which accounts for roughly 80 percent of illicit financial flows from developing countries. The G8 should commit to publishing all export and import data publicly online on a monthly basis, identifying products traded by the 10 digit Harmonized System identifications, as the United States currently does. Accessible trade data can do more to curb abusive transfer pricing and other trade mispricing than any other process.
Opponents to these reforms have argued that this agenda is unrealistic, cumbersome, and anti-business or anti-capitalism. Mr. Cameron has already refuted the last claim; enforcing laws, clarifying rules, and correcting information gaps supports a strong economy and business sector. The successful curtailment of shell banks in the previous decade demonstrates how changing this status quo of financial opacity and abuse is possible and relatively simple. If the G8 Leaders muster the political will, they could transform global finance into a system that is more stable, resilient, prosperous, and fair.
Tom Cardamone is Managing Director of Global Financial Integrity (GFI), a research and advocacy organization based in Washington, DC. Christine Clough is a Senior Program Officer at GFI.
This article was originally published in the special annual G8 Summit 2013 edition and The Official ICC G20 Advisory Group Publication in June 2013. It has also been published by the Diplomatic Courier.