Global Financial Integrity

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Following the Money: Tracking Illicit Cash Flows from Developing Countries

Raymond Baker

The US is the second easiest country to open a money laundering firm in. And despite tax reforms, the government is perilously behind in the movement for corporate transparency

This article was originally published by the Global Development Professionals Network section of The Guardian.

In March 2010, facing high unemployment in the wake of the largest financial crisis since the 1930s, the US Congress passed the Hiring Incentives to Restore Employment Act (Hire), hoping to stimulate the American job market. While the Hire act dominated news headlines at the time, a lesser-known provision of the legislation, known as the Foreign Account Tax Compliance Act (Fatca), was included in the bill as a means of paying for the stimulus measure. Few people remember the Hire act; Fatca was a real game changer.

For the first time ever, foreign financial institutions were required to report information to the Internal Revenue Service (IRS) about their American clients, or they would automatically face a 30% tax on their US source income. This quintessentially American—my way or the highway—approach to tax policy indubitably ruffled some feathers. However, the result of the legislation has been the largest collaborative, cross-border crackdown on tax evasion in history.

Almost immediately foreign nations demanded that the US government reciprocate—asking that the IRS share with them information on their citizens with accounts in US banks. Within a few years, the G20—the 20 largest economies in the world—adopted automatic tax information exchange between jurisdictions as the new global standard, removing decades of banking secrecy that protected individual tax evaders and criminals.

According to research and advocacy organisation Global Financial Integrity, nearly $1tn in illicit financial flows—the proceeds of crime, corruption, and tax evasion—flows illicitly out of developing countries every year. Horrible as this may be, it was not a driving impetus behind the passage of Fatca. The US Congress and administration were more interested in recouping some of the roughly $150bn missing from the US Treasury each year due to offshore tax haven abuses.

Regardless of the motivations, Fatca has been one of the most significant drivers in the fight against illicit financial flows to date. It laid the foundation for the European pilot programme of automatic information exchange on a multilateral basis, expanded this week to include its first African nation: South Africa. Moreover, every member of the G20, including Russia, China, India, and Brazil have agreed to exchange tax information automatically by the end of 2015.

But automatic exchange of tax information is only one pillar in the fight against illicit financial flows. While the US accidentally found itself a leader on the issue of tax information sharing, it remains perilously behind in the movement for corporate transparency.

The US Department of Justice acknowledged last year that anonymous shell companies are the number one tool used by criminals to launder their illicit funds. Remarkably, researchers at Brigham Young University, the University of Texas, and Griffith University found that the US was the second easiest place in the world after Kenya to open one of these phantom firms. These disguised corporate entities have been used to funnel weapons to terrorists and drug lords, they’ve been used to plunder corrupt funds from some of the poorest countries in the world, and they’ve been used to defraud Medicare—the national health insurer for elderly Americans—of billions of dollars.

The answer to this problem is making it mandatory for all companies formed in the US to disclose the true, human “beneficial owners” of the company in a central public registry that can be searched by law enforcement, investors, and due diligence officers.

While that appears unlikely to happen anytime soon, the Obama administration has endorsed legislation to require that the true owners of these phantom firms be available in central registries to which law enforcement have access, without requiring that this information be made public. The Incorporation transparency and law enforcement assistance bill, which is bipartisan, has been introduced in the US Senate to do just that, and it is expected that a house version of the legislation will be introduced in the near future.

Now it is time for the Obama administration to put its money where its mouth is. If president Obama truly believes in tackling illicit financial flows, crime, and tax evasion, then the White House needs to call on individual members of Congress to support this legislation.

The president committed to cracking down on phantom firms in his G8 action plan and in his open government partnership action plan. The US must now uphold those commitments.

As we’ve seen with Fatca, America is in a unique position to influence the global agenda. Citizens around the world are counting on us to do it again with corporate transparency.

Raymond Baker is president of Global Financial Integrity, a Washington-based research and advocacy organisation, and author of Capitalism’s Achilles Heel: Dirty Money and How to Renew the Free-Market System.

This article was originally published by the Global Development Professionals Network section of The Guardian.