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Maya Forstater is a visiting fellow at the Center for Global Development and a researcher and advisor on business and sustainable development. Her work focuses on the intersection of public policy, business strategy and sustainability including questions around tax and development, financing for low carbon investment and multi-sector partnerships and standard setting.
From 2014-2016 she was Senior Researcher for the UNEP Inquiry into the Design of a Sustainable Financial System. She has also worked with the Transparency and Accountability Initiative (for the Open Government Partnership), the South African Renewables Initiative, the Global Green Growth Initiative, AccountAbility and the World Business Council for Sustainable Development. She started her career at the New Economics Foundation, and was involved in setting up the Ethical Trading Initiative. She has published reports and articles on issues including the scale of international tax avoidance and evasion, corporate responsibility by Chinese businesses in Africa, the design of pay-for-performance climate finance mechanisms and the governance and effectiveness of multistakeholder partnerships.
It's that time of year again when presidents, CEOs and civil society leaders get together at the World Economic Forum in Davos, Switzerland, leaving the rest of us to wonder whether it is really true that a small number of very rich people at the top of the income distribution own more than the bottom half of the world.
Oxfam’s annual Davos calculation declaring that “the top [X] people have the same amount of wealth as the bottom 3.5 billion,” followed by responses from various skeptical commentators, is in danger of becoming a January tradition. (See for example Ezra Klein, Chris Giles and Felix Salmon and for a response to their criticisms, Nick Galasso). This year’s calculation from Oxfam says X=62.
Defenders of this killer fact argue that quibbling over the numbers is besides the point; it is a useful headline to attract attention to the disparity between the world’s richest and poorest.
But the neat and shocking equivalence between the wealth of a Davos shuttle bus-load of billionaires and that of half the world’s population may also be beside the point. The calculation works not because 62 people own the vast majority of everything (they don’t), but because 3.5 billion people own barely anything. Both groups own less than 1% of the world’s wealth.
It is all too easy to overestimate the development dividends from morally satisfying policies.
The bottom 3.5 billion are those with less than $3,210 in personal net assets. The vast majority live in low and middle income countries where being asset-poor means having limited access to healthcare, education, job opportunities, security, and justice. As Branko Milanovic says, "only in rich countries can wealth-poor people live reasonably good lives." In other words, Oxfam’s neat statistic on inequality may simply reflect the persistent problem of poverty and underdevelopment.
Inequality can undermine development and entrench poverty. Unequal access cements privilege and exclusion into the design of institutions and markets and prevents productive use of assets. Income inequality can be a sign that people at the top are abusing market power and controlling assets in illegal or unethical ways. Extreme inequality can lead to cycles of political and economic instability.
But the danger of focusing the inequality debate on the disparity between the global ultra-rich and the bottom 3.5 billion is that it ignores national policies and politics. It gives the impression that extreme wealth in the North and pervasive poverty in the South are simply two sides of the same problem — solve one and you can solve the other.
Rich people and multinational corporations make for attractive and accessible villains in a world where global value chains are seen to be pervasive and immiserizing. But the reality is that levels of income remain largely dependent on where people live in the world, and that poor people are not so much exploited by globalization and international capital markets as they are excluded from it.
It is all too easy to overestimate the development dividends from morally satisfying policies (as we have seen in tax debates). The desire to "even it up" implies that we can have “development without development,” by simply redistributing assets from rich to poor. Effective taxation is important but countries become wealthier through technology absorption, increases in productivity, and the adoption of the rule of law. Oxfam is right to take a critical view of the financial system, global supply chains, intellectual property rights and international tax rules, and to question whether they are fit for purpose. The challenge is to develop rules and institutions that are designed to promote inclusive growth, rather than to punish or constrain it.
International debates on taxation and development have been informed by a popular narrative that there is a large ‘pot of gold’ for funding which could be released by cracking down on the questionable tax practices of multinational enterprises, and which could bridge the gap towards funding the sustainable development goals. How much of this is wishful thinking and how much really reflects what we know? This paper looks at the 'big numbers' that have shaped this debate and seeks to clarify the emerging evidence.
At the Financing for Development conference in Addis Ababa this week, the issue of international cooperation to address ‘tax dodging’ and illicit flows will be higher up the agenda than ever before. Credit for this is due in no small part to the various non-governmental organizations that have built up public consciousness and pressure through sustained campaigns focused on the tax affairs of multinational companies.
In the attached paper, we find that the potential for governments to raise additional revenues by taxing multinational companies is limited by the actual levels of profit generated by foreign direct investment in each country; changes to effective tax rates may also have impacts on investment prospects. Estimates of corporate tax dodging are often presented, mistaken, or repurposed in a way that exaggerates potential impacts - for example, large aggregate tax loss estimates are compared with aid revenues or healthcare funding gaps, implying that taxes raised in China, Brazil and South Africa might be available for public spending in Cambodia, Haiti and Malawi. Multi-year tax estimates are compared with annual costs of nurses or teachers. In some cases larger estimates (‘trillions’) which relate to estimates of corruption, informal sector activities or offshore assets held by domestic citizens are mistakenly repurposed to represent complex tax planning practices of multinationals. Much-quoted figures such as ‘‘developing countries lose three times more to tax havens than they get from aid each year” and “‘60% of global trade takes place within multinationals” or “Zambia could have doubled its GDP” are not likely to hold up.
Taxes are a critical source of revenues for development and we appreciate these preliminary findings could be controversial. We welcome comments on our blog as we take the next steps towards a better understanding of tax avoidance and domestic resource mobilization.
One thing that's clear is that data are scarce, which in turn makes it hard to find robust and broadly-supported analyses. Instead, a popular narrative has emerged that the amounts involved are very significant in relation to the revenue base of the poorest countries, and that tackling tax dodging would generate enough funding to achieve ambitious development goals. Recent estimates (such as by the IMF and UNCTAD) put the scale of potential revenues in the region of $100- $200 billion; mostly in the large, emerging economies--it is hard to square these figures with the perception that additional taxes collected will be in problem-solving amounts for the economies of the poorest countries.
We live in a world of imperfect information and we acknowledge those who have made the effort to get the conversation going. We also understand that public statements are designed to get the attention of policymakers who are often occupied with other things. It is our hope that the draft paper builds on the work already done to move towards better numbers. We grateful to the many tax experts from across research, advocacy and tax professions who have contributed so far to discussions and debates around this paper and to helped to clarify assumptions and misunderstandings, including our own. In particular, we would like to acknowledge our advisory group--Alan Carter (Her Majesty's Revenue and Customs), David McNair (ONE), Judith Freedman and Mike Devereux (Oxford Centre for Business Taxation), Marinke Van Riet (Publish What You Pay), Mike Truman (retired editor of Taxation magazine), Paddy Carter (Overseas Development Institute), Robert Palmer (Global Witness), Heather Self (Pinsent Masons), Wilson Prichard (International Centre for Tax and Development), Gawain Kripke (Oxfam America), Jonathan Glennie (Save the Children) and Jeremy Cape (Dentons). The advisory group members participated as individuals rather than as organizational representatives, and the paper is not a collective product. Nevertheless it has been strengthened by their inputs, and their willingness to engage openly to try to find areas of common understanding, and clarify the basis for disagreements.
Here’s an obvious truth: tax lost to trade misinvoicing in Africa does not equal tax lost to transfer mispricing by multinational corporations in Sierra Leone, which does not equal lost health-care spending. Unfortunately, a policy paper released on Tuesday by Oxfam makes exactly these equivalences. This sort of imprecision is widespread, and it’s not going to help the poor.
The Oxfam report calculates that US $6bn of tax revenue was lost by African countries as a result of transfer mispricing by G7-based firms in 2010. This is based on an assessment of trade misinvoicing from the report of the UNECA High Level Panel on Illicit Financial Flows from Africa (table AIII.4).
The Oxfam paper is primarily misleading because it conflates trade misinvoicing with transfer mispricing, when these are very different things. Trade misinvoicing is the general practice of manipulating the price, quantity, or quality of a good or service on an invoice so as to shift capital illicitly across borders. Transfer mispricing is much more specific; it occurs when two affiliated firms (e.g. subsidiaries of a multinational) are transferring goods or services and this is not priced at the same rate an unaffiliated firm would have had to pay, illicitly shifting capital from one firm to the other.
The figures on trade misinvoicing relied upon by Oxfam relate to both affiliated and non-affiliated firms, and concern local actors as well as multinational corporations. Reducing this complex picture to bad behaviour within multinationals doesn’t help anybody to tackle real problems in taxation.
This [US $6bn] is equivalent to three times the amount needed to plug the healthcare funding gap in Ebola-affected countries of [sic] Sierra Leone, Liberia, Guinea and at-risk Guinea Bissau.
This is misleading because it suggests that eliminating trade misinvoicing would provide sufficient resources for health-care reform in countries like Sierra Leone. In fact, the UNECA report relied upon by Oxfam uses figures (Statistical Appendix Table 4) from Global Financial Integrity that suggest that the countries mentioned in the quote above accounted for, respectively, 0.28%, 0.40%, 1.00% and 0.06% of their estimate for trade misinvoicing in Africa from 1970 to 2008. So, even if the lost tax revenue could be recovered by the countries concerned, very little of that money would be available in the countries Oxfam mentions.
The quote also implies that African governments would spend the extra revenue, 1:1, on health. In fact, we know that this would not be the case. Governments spend their money on all kinds of things, and finding financing for development is a complicated problem. We should not suggest that there is a sufficient ‘pot of gold’ to be had by only paying attention to corporate tax avoidance, as we pointed out in a recent CGD blog.
This is not to say that corporate tax avoidance isn’t important. It is: taxation of multinational corporations is a significant source of financing for development, and improvements and reforms in tax policy and implementation could potentially increase this, but it is nowhere near sufficient. When organisations like Oxfam equate misapplied estimates of corporate tax dollars lost to health spending needed, they are enabling policy makers (and tax payers the world over) to avoid the hard questions about where the rest of the money will have to come from to finance development.
A forthcoming CGD working paper by Maya Forstater will look at the “big numbers” that have shaped the tax debate. It will try to separate out the numbers that make sense from those that don’t, with the aim of improving the quality of the debate around tax reform.
Taxation, which has been a Cinderella subject in development, has finally been invited to the ball, but the arguments that have helped to push taxation up the finance-for-development agenda may also be in need of clarification.
There is widespread perception that (1) there are huge areas of untaxed or undertaxed economic activity in the poorest countries, (2) undertaxing is mainly a product of clever “tax-dodging” practices of multinational corporations, with armies of lawyers and accountants, and (3) gaps in basic health care, education, and infrastructure could be solved by a few changes to international tax policy and transparency.
And more broadly there is an inconvenient truth that these ‘big numbers’ (in the region of $100 billion) are just not that big, amounting to a 1 or 2 percent increase in overall tax revenues, according to a recent study by UNCTAD, with the biggest sums concentrated on larger emerging economies. The headlines about bringing billions out of poverty and closing gaps in basic services seem to be based on the assumption that every penny of additional tax raised would go to social spending and would cross borders effortlessly. But taxes raised in countries such as China, Indonesia, and Russia are unlikely to be available for buying mosquito nets and exercise books in Mozambique and Mali. (NGOs are not the only ones to say this: the OECD’s soundbite that developing countries lose three times more to tax havens than they get in aid seems to be based on a similar conflation of big and small economies).
A polarizing dynamic has emerged in which these numbers, and the perception that they represent problem-solving sums of money for the poorest countries, have got a life of their own, and have become a barrier to understanding the problem of domestic resource mobilization. While no one argues that initial rough estimates are sufficient for evidence-based policymaking, criticizing or questioning these estimates often tends to attract rebuttals and accusations of “defending tax dodging”.
That is not constructive. Tax policy discussions should be based on sound analysis. Civil-society advocates, policymakers, and tax experts need some common ground of concepts, definitions, and data to be part of the same conversation.
We are contributing with a small project to determine how estimates related to tax avoidance and tax reforms should be interpreted, what they tell us about the potential for specific policies to raise taxes in specific countries, what we know (with what degree of confidence), and what has just become de facto common knowledge because it has been repeated so often.
The result will be a short report with a long acknowledgements list. As a first step we have drawn together an advisory group including Alan Carter, HMRC; Paddy Carter, ODI; Mike Devereux and Judith Freedman, Oxford Centre for Business Taxation; David McNair, ONE Campaign; Robert Palmer, Global Witness; Wilson Prichard, International Centre for Tax and Development; Heather Self, Pinsent Masons; Mike Truman, recently retired as editor of Taxation; and Marinke van Riet, Publish What You Pay (all participating as individuals). Alex Cobham from the Tax Justice Network also participated in the first meeting to discuss the issues.
There was considerable agreement among the group that better analysis is needed to support nuanced policy discussion but disagreement about whether the initial use of rough-and-ready calculations and name-and-shame accusations was justified as a way to raise attention about a poorly understood and under-resourced policy area.
What do you think? Do the ends justify the means? What is the best way forward to improve domestic resource mobilization?
Clay Lowery, our group’s chair, is Vice President at Rock Creek Global Advisors, an international economic policy advisory firm, where he focuses on international financial regulation, sovereign debt, exchange rates, and investment policy. He is also a Visiting Fellow at the Center for Global Development and serves on the Policy Advisory Board at the European Institute. He was an Adjunct Professor at Georgetown University in international finance and a lecturer at the National War College.
The UK Labour Party recently set out its ideas on international development in a paper titled “A World for the Many, Not the Few.” There is much to like in the policy paper, including pledges to put in place an effective whole-of-government development approach, to advance DFID’s monitoring of whether aid reaches the most vulnerable and excluded, and to communicate more honestly with UK taxpayers about the successes, challenges, and complexities of development.
But its core innovation is a proposed change in legislation to add reducing inequality to the required criteria for aid spending (alongside reducingpoverty), while at the same time “reducing the importance of GDP growth.”
Jonathan Glennie, Director of the Sustainable Development Research Centre at Ipsos, offers a helpful mental model for the difference between reducing poverty and inequality:
Imagine two cars racing, one substantially ahead of the other. Now imagine the slower car speeding up—that’s poverty reduction. . . . If the car in front goes even faster—that’s widening inequality.
As Branko Milanovic has highlighted, global inequality has grown over two centuries, driven largely by inequality between countries (to use the racing cars analogy, if we imagine country populations are teams of cars, the largest gaps opened up between the teams of cars, with teammates bunched up together, rather than between cars on the same team). Since the 1980s, emerging economies have started to close the gap with richer economies through sustained economic growth, at the same time that inequality within some countries has widened. As levels of poverty have fallen faster than ever before in human history, there are fewer cars travelling at extremely low speeds.
In “A World for The Many, Not the Few,” Labour states that it would adopt a standard metric to assess progress on national inequality. The risk is that this metric will, perhaps inadvertently, characterise hundreds of millions of people who would be considered poor by rich-world standards as getting too rich too quickly. With poverty and global inequality still stark—700 million people remain in extreme poverty (below $1.90 a day) and the majority of the world’s population lives below $10 a day—should the UK really be shifting its focus away from poverty reduction, national development, and broad economic growth towards tackling inequality within poorer countries?
Confusing the richest 10 percent in poor countries for the global elite
The Sustainable Development Goals includes a target on national inequality which, in motor racing terms, divides each country’s population between 10 cars and focuses on accelerating the last four cars to close the gap with the pack ahead. “A World for the Many, Not the Few” argues for “raising the bar on SDG Goal 10” by focusing on the gap between the last four cars and the car at the very front of the team (this is known as “the Palma ratio”: the ratio of income between the richest 10 percent and the poorest 40 percent of the population). The paper says that a Labour government would adopt this as the metric for assessing progress on inequality by its development partners. It would encourage all countries to pledge to halve their Palma ratio by 2030 and achieve a ratio of 1 by 2040 (Sweden, Denmark, and the Netherlands each have a ratio of 1).
The chart below shows the income levels of the top 10 percent and the bottom 40 percent together with the Palma ratios for 12 of the 20 largest recipients of UK bilateral aid.[*]
The data shows that the poorest people are very poor, with average consumption amongst people in the lowest decile in DRC, Ethiopia, Kenya, Malawi, Sierra Leone, and Uganda less than $2 per day, and in the other countries a dollar or two more. But people in the top decile are not recognisably rich. In DRC and Sierra Leone, the richest 10 percent of people consume on average less than $10 a day, a level considered impoverished in rich countries. In Ethiopia, Malawi, Nepal, and Uganda, the mean of the top decile is only a few dollars more (these are purchasing power parity dollars, so it is not that the cost of living is less). In Bangladesh the mean income of the top decile is 20 percent less than the Asian Floor Wage, which its promoters argue is what a worker in a garment factory with a dependent family should be paid to have enough to live on (this tells us something about why living-wage campaigns have been so intractable, but it also makes clear that the threshold of the richest 10 percent in Bangladesh is a long way from the global elite).
The chart below shows income by decile for the same set of countries, with the UK included. In none of the 12 countries is the average income of the top 10 percent higher than the UK’s minimum wage.
It is notoriously difficult to assess income distributions (particularly at the very top of the range), and some of these measures rely on surveys that are several years old. Still, the overall pattern is clear: while there will be a small proportion of very rich people at the top of the distribution, there will also be many more people within the top 10 percent earning less than the mean.
Lant Pritchett points out something similar in relation to the quality of education globally. In most developing countries it is not that “the rich get a good education and the poor get a bad one” but “the rich get a bad one and the poor get none at all.” For example, in standardised educational test scores, 15-year-old students from Thailand, Mexico, Mauritius, and Chile fall below the 20th percentile of students in Denmark. Students from Qatar, Ghana, Saudi Arabia, and El Salvador fall below the 5th percentile when compared to their counterparts in Australia.
“A World for the Many, Not the Few” argues that “what people need and want in the UK, people need and want everywhere: our needs, our rights and our struggles to achieve them are one and the same.” Yet at the same time it suggests a development target which counts improvements in the living standards of people who would be considered amongst the poorest in the UK as eroding progress, suggesting that their advancement should be slowed down. What moral authority can the UK have to tell people whose incomes are barely comfortable, and whose priorities are overwhelmingly for jobs and economic growth, that their ambitions and aspirations should be put on hold in pursuit of “happier and more harmonious societies”?
Beyond crude measures
There are certainly reasons to be concerned with inequality within countries. Angus Deaton argues that we should view inequality not so much as a cause of economic, political, and social processes, but as a consequence. Some of these processes are good (areas of economic growth in poor countries), some are bad (uneven access to opportunities), and some are very bad indeed (extractive political institutions and monopoly rents). He argues for sorting the good from the bad in order to understand inequality and what to do about it. As Nancy Birdsall highlights, a rising number of people with steady jobs, a secondary education, and a stake in rule of law and protection of private property rights is a development good, not a development bad, not only for those people directly, but because growth of a middle class in emerging economies has been intimately linked with poverty falling.
DFID should support efforts to address damaging causes of inequality—rigged markets and politics, rent extraction, lack of political voice and agency—and work to increase the productivity and market power of the poor and the emerging middle of workers, traders, and consumers. But if DFID manages-to-the-metric, it might mean refusing to support any investment that would have a first-round effect of increasing incomes in the top decile, including improving the lives of Malawians earning more than $10 a day or Sierra Leoneans earning over $5. It might also mean prioritising projects supporting the 40 percent poorest in Kenya over the poorest 40 percent in the DRC, because even though they are richer, their country’s Palma ratio is higher.
More broadly, the goal of achieving some mathematically Scandinavian level of equality in poor and middle-income countries, and the general disparagement of economic growth in the paper, suggest a zero-sum view of prosperity, which is not in line with people’s aspirations, or their possibility. As Simon Maxwell notes, the paper focuses on the “narrative of predation” but misses out on a companion “narrative of accumulation,” by which countries and people prosper: trade, technology, migration, and mobilisation of finance. Migration, probably the most powerful lever that developed countries for enabling poorer people to improve their lives, barely gets a look-in. As E. Glen Weyl highlights, much migration exacerbates inequality both in sending and receiving countries, and yet reduces global inequality. It is a difficult political issue, much harder to communicate than the story of venal global elites, and it is a gaping hole in Labour’s articulated vision of a fairer world.
Domestic taxation, public services, and redistribution are important, and the consensus, (including from researchers at the IMF) is that moderate redistribution does not impede growth. But it is easy to fall into an overoptimistic vision of what can be achieved through taxing the rich and domestic redistribution. The truth is the many are too poor, the middle too few, and the elite just too tiny for evening up income levels while “reducing the importance of GDP growth” to be the answer for broad prosperity in poor countries.
[*] Where data is available. I also left out Jordan and Lebanon because a large proportion of aid to those countries is focused on refugees rather than on the general population.
A new Criminal Finances Bill is making its way through the UK House of Commons which aims to make it harder for criminals and kleptocrats to use the UK financial system to launder ill-gotten gains, while minimising the burden on legitimate businesses and individuals. The bill gives expanded powers to law enforcement agencies and makes banks and other businesses liable for prosecution if they fail to prevent facilitation of tax evasion. It also introduces ‘Unexplained Wealth Orders’ (UWOs). These would allow the authorities to demand explanations about any assets that appear suspicious. These measures should have both domestic and international benefits in tackling illicit financial flows.
At the end of December a new amendment was introduced, supported by a cross-party group of over 80 MPs. It seeks to force the UK’s Overseas Territories publish open registers of the ultimate (‘beneficial’) owners of companies (a step that the UK took last year).
What are the Overseas Territories and Crown Dependencies?
‘Overseas Territories’ are 14 jurisdictions; former parts of the British Empire that have their own domestic legal systems, but which have chosen to remain in close partnership with the UK. They are mainly small island states and include several Caribbean jurisdictions which have developed specialisms in international financial services such as Anguilla, Bermuda, British Virgin Islands, and Cayman Islands. Jersey, Guernsey, and the Isle of Man are known as ‘Crown Dependencies,’ they have a slightly different relationship with the UK but also have their own legislative assemblies and legal systems.
It is extremely rare for the UK to impose rules on its Overseas Territories (or its Crown Dependencies). There have been a few precedents but they tend to be motivated by fundamental human rights issues, such as abolishing capital punishment, and decriminalizing homosexuality, or in response to major governance failure; such as when the UK imposed temporary direct rule on the Turks and Caicos Islands. Margaret Hodge, who sponsored the amendment said, “of course political parties have shied away from using these powers. They can seem somewhat colonial, but I think there are overwhelming moral arguments at stake here.” This blog post considers the arguments and the evidence.
Anonymous ‘shell companies’—which allow people to hide their identity behind nests of interconnected companies and nominee directors—have been identified as a key chink in the armour in anti-money laundering rules, making it hard to trace the spoils of crime and corruption. When the World Bank reviewed 213 grand corruption cases with proceeds worth $50 billion it found that 70 percent of them involved the use of at least one anonymous company or trust. However this should not lead to the perception that every shell company is used for illegitimate purposes. For example, Transparency International points out that four out of five of the 144 London properties which have been investigated as proceeds of corruption over the past 10 years involved shell corporations. However these properties make up fewer than 0.25 percent of London properties held by foreign companies. The Director of Operations for the Metropolitan Police’s Proceeds of Corruption Unit notes that “the percentage of properties purchased via illicit money is tiny in comparison to the legitimate trade.”
The international standard for transparency on beneficial ownership, set by the Financial Action Task Force (FATF), states that “countries should ensure that there is adequate, accurate and timely information on the beneficial ownership and control of legal persons that can be obtained or accessed in a timely fashion by competent authorities.” This does not require an open public register, and other countries have taken different approaches to the UK. Options include regulating Corporate Service Providers (CSPs) to ensure that they collect and verify information about the real owners of companies, and establishing closed central registries which are only accessible to law enforcement.
Mystery shopping for secrecy
The World Bank’s Puppet Masters report undertook an in-depth examination of anonymous shell companies (including through a practical ‘mystery shopper’ exercise where they attempted to register anonymous companies in different jurisdictions). They concluded that requiring professional CSPs to collect and verify information about the ultimate owners of companies is a much more effective way of ensuring reliable information than relying on self-reporting to a central register. The Global Shell Games Project undertaken by Jason Sharman, Michael Findley, and Daniel Nielson followed up with a randomized experiment, where they sent 7,400 email solicitations (in various shades of dodgy) to more than 3,700 Corporate Service Providers in 182 countries to test whether they would follow international rules by requiring proof of identity. Nearly half did not ask for proper identification. Perhaps surprisingly, company service providers in OECD countries like the US and UK were more willing set up companies without checking identity documents, while CSPs from small state financial centres were more likely to follow the rules.
Sharman argues that CSPs should be regulated and required to collect documents establishing the true identity of beneficial owners. However, confidence in this system has been rocked by what has become the most well known CSP in the world—Mossack Fonseca. While the vast majority of the 500,000 companies included in the ‘offshore leaks’ have not been linked to any scandal, the ‘Panama Papers’ highlighted a particular weakness in CSP regulation. In some jurisdictions such as the BVI, an ‘eligible introducer’ exemption allowed CSPs to register companies for customers whose identity was vouched for by an on-shore bank or law firm. The idea is that onshore firm are better placed to collect and verify ‘know your customer’ documentation from local customers than offshore service providers, and it is more efficient to do this once. However this system can break down if the CSP does not hold a copy of the information, and the eligible introducer later declines to produce it or says they do not have it. Jurisdictions may also drag out the process of mutual legal assistance, delaying responding to requests for information.
Could ‘many eyes’ provide low cost verification?
Central registers it easy to access beneficial ownership information, but they don’t do anything to assure it is reliable, as they generally rely on self-reporting, and registrars do not have capacity for verification. Relying on crooks to honestly self-register seems fool hardy, but hope has been placed on the idea that open databases might be more accurate because of the role of the public, journalists and NGOs in data verification.
Data from from UK’s first release of beneficial ownership information shows the scope and limitations of this approach. Global Witness brought together 30 volunteers over a weekend to look at the data. Their experience highlights the hopes and practical limits of open registers. They compared the UK register with other datasets such as the US sanctions list and lists of politically exposed people—but recognised that they had no means to check whether their ‘hits’ reflected people sharing the same name and birthdate, or indeed whether there were other people that their database crunching had not detected because they did not submit honest information to the register in the first place. Their searches were able to pick out companies whose beneficial owner was given as a company instead of individuals. However without the power to demand further information all they were able to do was pass the matter back to Companies House for their attention. Hera Hussain at Open Corporates notes that seeking to investigate clues of corruption or money laundering by combing through the database is a needle-in-a-haystack experience.
It is certainly worth these organisations continuing to test and investigate what use can be made of the UK’s public beneficial ownership register. But we still don’t know whether an open, unverified register is necessarily preferable to a regulated system. Verifying beneficial ownership information is a routine process. It is important but boring, and relies on triangulating with other information which may not be in the public domain. There are very few needles in a very big haystack of basically law-abiding companies. For example there are over 3.5 million registered companies in the UK. According to the UK National Risk Assessment on Money Laundering and Terrorist Financing in 2013/14, Companies House handled some 9 million filings and registrations. They received complaints and reports of errors relating to in the region of 0.3 percent of companies, and say that in 80 percent of these cases, companies corrected the information immediately, suggesting that the cause was simple error, rather than fraudulent activity. In the vast majority of cases with no particular scandal to investigative it is not clear that journalists, NGOs or other volunteers would be motivated or able to comb through the haystack. The may also lack the information, power, or resources to do it efficiently.
Does privacy matter?
Open self-declared public registers are relatively cheap to set up, particularly for a country like the UK which already has an open corporate register. For developing countries and overseas territories that do not already have the infrastructure of a central register it is a bigger expense, and for those for whom privacy is part of their attraction to customers, it undermines the competitiveness of their offering.
Much, then, comes down to the question of whether it is legitimate to enable law-abiding people to pursue a preference for privacy over the assets they own and the investments they make, so long as they are not able to evade taxes. Should the privacy of the many be overridden by the goal of making life harder for the few money launderers and tax evaders?
While there are clear areas where it can be argued that beneficial ownership should be made public (such as for Politically Exposed Persons, owners of shipping vessels or when a company is bidding for a public contract or concession) this does not necessarily require that all people who own assets through corporate structures be required to put the details of their holdings in the public domain.
There is an overwhelming case for learning
Different jurisdictions are taking different approaches to securing beneficial ownership information: Most international financial centres use regulated CSPs. The British Virgin Islands has recently taken action to close the ‘eligible introducer’ loophole, and is also developing a central register. The EU has adopted central registries which are not public, but whose records may accessed by people with a 'legitimate interest'. Jersey combines a closed central register with strong CSP regulation. The UK, Germany, France, Italy, and Spain have agreed to develop automatic exchange of information. Ukraine Netherlands, Australia, South Africa, and Nigeria have indicated that they intend to develop public registers. The US has long been the easiest place to register an anonymous company, as it has neither licenced CSPs nor registries, although the IRS has strong powers to demand information. The role of banks in identifying beneficial owners and providing information to tax authorities though the Common Reporting System (CRS) is also crucial for closing down routes for tax evasion.
Targeted approaches to making beneficial ownership public are being made in relation to the extractive industries, public procurement tenders and contracts, shipping vessels, and in asset declarations by Politically Exposed People. Technological solutions offer the opportunity to leapfrog traditional paper-based approaches. Global Legal Identifiers for companies are being developed to enable firms to better understand who they are doing business with. Digital approaches may also help to overcome the barriers to access to financial services, social benefits, and political rights for the 1 in 5 people around the world still unable to prove their identity. As Mark Carney recently highlighted, solving this problem through digital ID systems would make existing due diligence requirements easier to fulfill and harder to evade, and would unlock the potential to for fintech innovation to serve more people.
Progress in any of these areas depends on adaptive processes of trying, failing and learning, and adjusting.
Rather than rating countries on whether they have particular iconic laws on their books, there is an urgent need to assess and learn what is working in practice, and to ensure pressure for improved performance by all jurisdictions to demonstrate that they are sound locations for legitimate business. This could include mystery shopper audits of CSPs to test whether due diligence is working, as well as tests of how quickly and cooperatively jurisdictions respond to requests for mutual legal assistance.
Otherwise we risk prematurely pronouncing a single solution, and encouraging policy makers to pass symbolic laws and policies in order to impress or to avoid punishment.
Updated 2/9/2017: This post has been updated to clarify the accessibility of the EU’s closed central registries.
Earlier this year, The Centre for Research on Multinational Corporations (“SOMO”; a Dutch NGO) issued a report about an international mining company they said had avoided paying $232 million USD in taxes in Mongolia.
The mine in question is the Oyu Tolgoi (OT) copper and gold mine and the company is Turquoise Hill, a Canadian company, 51 percent owned by the Australian mining giant Rio Tinto. The Oyu Tolgoi mine is considered a big deal in Mongolia and has been subject to lengthy negotiations on how to split the risks, costs, and profits of the project between the company and the government. While this question is of primary interest to the people of Mongolia, I think that delving into the detail of individual cases like this is also important for clarifying the broader debates and understanding of tax issues.
SOMO say their report “reveals how Rio Tinto has managed to pressure the Mongolian Government into signing deals that are detrimental to its own interests” and in this way “been able to design and preserve a tax dodging scheme that has allowed it to persistently avoid substantial tax payments to Canada and Mongolia.” Oxfam uses it as an example of “how poor countries like Mongolia may be losing millions because of corporate tax practices and legal loopholes.” Turquoise Hill in response say that the report is inaccurate and misleading. They say the investment deal was openly agreed with the Government of Mongolia and that the company’s structure (which involves subsidiaries in the Netherlands and Luxembourg) does not reduce tax in Mongolia, and is in compliance with Canadian tax laws.
Both the NGO’s allegations and the company’s defence rest on the same core documents—in particular, the investment agreements between Turquoise Hill and the Government of Mongolia. It is widely accepted that such contracts should be out in the open. The idea of contract transparency is that it will result in more stable and durable contracts, both because they are less subject to public suspicion and because governments and companies will negotiate better deals. Several governments have made commitments to contract transparency on natural resource concessions, and supporters include the World Bank, the IFC, the IMF, the Publish What You Pay coalition, and the Natural Resource Governance Institute (NRGI). As one report puts it:
States and companies may not be hiding anything of great import, but so long as contract disclosure is scattered and leaked materials suggest hidden horrors, that perception will persist—providing easy fodder for demagogues and politicians to make calls for expropriation and renegotiation in cases where it is not merited.
All of the OT Investment agreements have been published and Turquoise Hill is covered by Canadia’s “ESTMA” revenue transparency regulations, while Rio Tinto produces an extensive “taxes paid” report. However, the Oyu Tolgoi case shows that just having these documents and data in the public domain may not be enough. It also matters what you do with them.
Open Oil (a social enterprise that specializes in public interest financial modeling) points out that debates about these kinds of deals often fall into the trap of the single term dilemma: you can point to any one element and argue that it is too high or too low, but what really matters is the overall division of earnings over time; when will each party start to see a positive return from the project, and what will their revenues look like over the 50+ years of operation? Is that fair? And is the investment viable?
Making sense of Oyu Tolgoi
The Oyu Tolgoi project is a massive, technically and operationally complex project. By the end of 2014 almost $7 billion had already been spent on developing it, and the total investment will be around $12 billion.
The thing that complicates the fiscal side of the deal is that the government is getting a 34 percent “carried interest.” Turquoise Hill and its shareholders are covering 100 percent of the upfront exploration and development costs but will only end up owning a 66 percent share of the project, while the government will not put up any of the up-front investment but will end up with a 34 percent share (through the state-owned enterprise Erdenes).
For this deal to work, it has to be acceptable on both sides, taking into account all of the costs and revenues and how they are distributed over time. The main ones are illustrated below:
Table 1. Costs and revenues: Government of Mongolia and Investors
0 percent of project costs upfront
Loss of amenity and natural resource
100 percent of project costs upfront
(+ risks, including fiscal regime issues)
Import taxes on inputs to the project
34 percent of dividends (-interest and principle on loan)
Corporate Income Tax
66 percent of dividends (post tax profits)
Interest on money loaned to government (payable out of future cashflows)
Management fee to Rio Tinto
+ economic spillovers, employment, technology, etc.
Reputation for developing a successful project >> future investment
Scale of the project
Open Oil has previously developed a model of Oyu Tolgoi’s finances and revenues. As it shows, Oyu Tolgoi delivers early revenues in the form of VAT, royalties, and customs and withholding taxes to the government—long before investors begin to receive dividends. Turquoise Hill say to date the project has paid out $1.7 billion in taxes and royalty payments and that the investor side will not commence to be cash flow positive until around 2026.
Figure 1. Open oil model of Oyu Tolgoi government revenues
(base case scenario, with 20 percent withholding taxes)
Are reduced withholding taxes “shameless abuse”?
SOMO’s belief that tax revenues to date should have been $230 million higher in Mongolia than they were, is based on the argument that the project ought to be paying a 20 percent withholding tax on cross-border interest on loans from the parent company (as is shown in the Open Oil base case) whereas in practice this has been reduced to lower levels.
Withholding taxes are taxes on the gross value of cross border payments such as interest. They are simple for governments to collect (compared to profit taxes), and are an important safeguard against companies shifting profits from high tax to low tax jurisdictions. Even in the absence of profit shifting, withholding tax are relatively attractive for governments because they start to generate public revenue early in the life cycle of an investment, rather than waiting for the project to be in the black.
However, a large tax on interest is like an import tariff on borrowing money; it raises the cost of capital. Therefore countries seeking inward investment often sign double tax treaties, which reduce withholding tax rates.
SOMO argues that the 10 percent WHT rate is abusive because it was secured using a double tax treaty with the Netherlands, which Mongolia has since unilaterally cancelled. However as Turquoise Hill points out, had the loans come from directly from Canada the interest would have been subject to the same 10 percent tax rate. Similarly, if the loans had come from the UK, France or Germany the rate would also have been 10 percent. In fact, when the Investment Agreement was signed Mongolia had 30 double tax treaties and only four of them had a withholding tax rate on interest that was different from 10 percent (one higher and three lower). When the IMF undertook a review of Mongolia’s Tax Treaties it recommended that Mongolia adopt a standard WHT rate of 10 percent for interest.
So the 10 percent rate seems unexceptional. However, SOMO also highlights an additional complication: the tax is only paid on the private investor’s portion of interest payments, and not on the portion that relates to the government’s share. Thus the 10 percent goes down to 6.6 percent in practice. SOMO sees this as a further (retroactive) lowering of withholding taxes. Its reasoning is that withholding taxes are formally a tax on the party that receives the interest payments—and not the party that makes the payments. It argues that therefore that “the logic behind this arrangement seems awed [sic].”
But their interpretation does not reflect the way that withholding taxes work in commercial practice. The cost of the tax has to be priced in and it typically raises the cost for the borrower, rather than lowering the return that a lender is willing to accept. In practical terms, interest rates are usually specified as “net of all taxes” with the borrower required to gross up the payment to cover any withholding tax. That means that if WHT was charged on Erdenes’ share of borrowing, it would be the government paying it to itself (by borrowing additional money from the project). This would bring forward revenues, but the value of the withholding tax would need to be taken off the value of dividends which might be received in later years, with added interest.
While it seems like an exaggeration (or a misunderstanding) by SOMO to call these issues “abuse,” their report does highlight a question about whether the implications of the treatment of WHT for the overall deal were fully understood. This is perhaps even more important going forward than in assessing the taxes paid so far. Using Open Oil’s base case model the difference between a 20 percent or 6.6 percent withholding tax on interest could be worth around $1.3 billion over the life of the mine (undiscounted), while the difference between a 20 percent or a 0 percent dividend withholding tax (as secured by the Netherlands treaty) is worth around $3.7 billion.
Turquoise Hill argue that it was always clear that the equity investor was a Dutch entity, and would therefore use the Dutch tax treaty. We cannot simply assume, as SOMO do that the project would be viable (or that there would not have needed to be concessions in other areas of the deal) if loans were subject to an additional 13.4 percentage points of withholding tax on interest (as well as a 26 percent tax on the interest received in Canada as SOMO also argue).
While it seems unlikely that the negotiators on either side would simply have left the question of withholding tax rates unsettled, what is not clear whether the implications for project’s revenues were clearly understood and communicated across the government and to wider stakeholders. The fact that neither the IMF nor Open Oil’s models of the project seems to correctly reflect the Netherlands tax treaty suggests that the implication of tax treaties were not widely obvious even to careful observers. Turquoise Hill and the Mongolian tax authority have also had large differences of opinion about how much tax is due from the company. In 2014 a bill was issued for $127 million USD for unpaid taxes from 2010 to 2013, which was subsequently cut by more than 75 percent on appeal. Turquoise Hill is currently in dispute with the Mongolian revenue authority over whether their outstanding taxes for 2013 to 2015 are $5 million or $155 million (it has been suggested by industry analysts that this also relates to withholding taxes).
Could contract transparency be better?
Natural resource contracts are increasingly put into the public domain. But as this case highlights, making sense of the numbers and the legal documents is not straightforward and deals remain open to claims of abuse and loopholes, which may not necessarily be well founded.
The World Bank, NRGI, and the Columbia Center on Sustainable Investment have sought to bridge the knowledge gap with the ResourceContracts.org database which annotates contracts to make them easier to find and understand. NRGI provides training and support to civil society organisation and parliamentarians in analysing contracts (including in Mongolia). Open Oil develops open source fiscal models of oil, gas and mining projects.
However, contract terms alone don’t tell the full story, and are easy to misinterpret. Ali Readhead and David Mihalyi argue that it would be beneficial if the Government of Mongolia and Turquoise Hill produced a joint communique on which WHT rates apply for the shareholder loan, the project finance loan, and future dividends.
More generally, perhaps what might be helpful would be to develop open public “term sheets” for oil, gas, and mining contracts which set out the basic variables contained in contracts and the relevant laws and treaties needed to develop a fiscal model. This would provide a crucial link between open contracts and fiscal models, and by using a standard template might be able to make clear whether each party, and the public have adequate information to judge the deal. Companies and governments could support public understanding by providing such information proactively, alongside publishing the detailed contracts.
If transparency about contract terms matters, then so too does the way that this information gets interpreted and shaped into stories. The SOMO report was developed according the organisation’s own quality standards: a draft was sent to Rio Tinto two days before Christmas and the final report published at the end of January, giving little time to engage with the company’s response. A single unnamed “fiscal practitioner” was consulted as peer reviewer. It is not clear whether this person had good knowledge of project finance, but it seems unlikely. Oxfam judged this to be good enough to take the story at face value, without a second opinion, and amplified it to a broader audience.
I don’t think those quality standards are adequate if what we want is serious and credible analysis. Getting better depends on consumers demanding better.
The consumers in this case are the community of people who think that it is worth reading, writing and funding (and quoting, retweeting, remembering, and using…) public analysis about the extractive sector and public revenues (if you got to the bottom this blog post you are part of this club). Accepting lower standards of analysis and review means giving up on trying to tell a real scandal from a sensational headline.
With thanks to Rhodante Ahlers and Vincent Kiezebrink, Ross Lyons, Ali Readhead, David Mihalyi, Dan Neidle, Alistair Watson, and Paddy Carter for thoughts and comments.
Misunderstandings about the scale of multinational tax avoidance are common. Last week’s example of this was perhaps the largest: Premium Times reported that Nigeria loses $1 trillion a year to tax evasion by multinationals. The claim was syndicated, repeated, and retweeted without question, including by organizations working on illicit financial flows, and several Members of the European Parliament.
$1 trillion is more than double the size of Nigeria’s whole economy and suggests additional corporate profits of nearly seven times the whole economy. Surely it cannot be true.
Premium Times has since updated the article removing the claim, but the syndications remain. And this is not the first time the $1 trillion figure has appeared. The same figure was widely reported in Nigeria last year (although some papers tried to make sense of it by reporting the figure as a trillion Naira).
So where does the trillion figure come from? Is it in dollars or Naira? What could it mean? Why is it so readily repeated? And can the confusion be cleared up so that no one else falls into the same misunderstanding?
The source seems to be a 2016 statement by the Information and Culture Minister, Alhaji Lai Mohammed, which several papers reported verbatim:
Where multinational companies operate in more than one country, it's quite easy for them to move profit from one territory to another territory where the tax law is very favourable to them. And what has happened over the years is that the revenue companies have lost a lot of money. As at the last count, over 1 trillion dollar has been lost over a period of time. And the revenue companies have found that they were losing more money in terms of tax evasion and avoidance than what they were even receiving as grants from multinational agencies.
So it is not just a typo between trillions and billions or dollars and Naira. But the reference to “revenue companies” is unclear. And where did he get this huge figure from?
The sound is not sharp, but if you listen and look closely you can see the Minister is not saying “revenue companies” at all, but “developing countries” (at just after 50 secs.).
If you are a follower of these big numbers you may have figured out the likely source and what he was talking about by now; $1 trillion is a widely cited (but problematic) estimate of illicit financial flows from developing economies. It is not a figure about Nigeria. Or about tax losses.
So the origin story for $1 trillion figure is a case of bad lip reading. But the explanation for why it proliferated is because it reflects the belief that there are absolutely huge sums of money for development at stake from cracking down on multinational tax avoidance, and that major companies are engaged in massive misinvoicing. The figure itself may be ridiculous but these myths are serious—they undermine both trust in revenue authorities and businesses, overheat disputes, and make it harder to judge practical progress on improving tax systems and compliance.
The Sustainable Development Goals (SDGs) include a target to “significantly reduce illicit financial and arms flows, strengthen the recovery and return of stolen assets and combat all forms of organised crime” (Target 16.4). However, there is no globally agreed upon definition for “illicit financial flows” (IFFs). My new CGD paper looks at why there is so much disagreement and confusion over this term.
Sandwiched between gun running, stolen assets, and organised crime in the Global Goals, it is clear that the core idea of illicit financial flows is concerned with “dirty money” that crosses international borders—one common formulation is money that is “illegally earned, transferred, and/or utilized.” This includes the proceeds of crime and corruption: illegal trade, embezzlement, bribes and kick-backs, terrorist finance, and misreported transactions that evade tariffs or taxes. In countries with foreign exchange controls, movements of money dodging currency controls would also fall under the definition. The idea of illicit financial flows is important because it highlights that crime and corruption are not just the problem of the country where they happen, but of the countries that allow their financial systems, goods trade or real estate markets to be used as getaway vehicles for ill-gotten loot.
Figure 1. Core concept of illicit financial flows
All of this seems relatively clear (although difficult to measure—such financial flows are obscured and hidden by design). However a case has also been made, for example, by coalitions such as the Global Alliance for Tax Justice and the Global Financial Transparency Coalition that illicit financial flows should be defined more broadly in relation to breaking some line of moral acceptability.
In practice this argument does not aim to draw up a list of morally acceptable and unacceptable things that people could do with their money (which would of course be impossible), but is focused on a particular issue; that “tax avoidance” should be included within the IFFs definition. This would bracket legally compliant taxpayer behaviour into a single category with criminal and corrupt money flows.
I argue that this broad approach is not coherent, and undermines the rule of law.
Grey areas on tax planning and tax evasion: not really so grey
One argument for taking the broad approach, which is often seen as compelling is the idea that there is a large “grey zone” reflecting an absence of clear defining lines between legal tax planning and tax evasion. Transfer pricing and trade misinvoicing are often highlighted as representing this overlapping practice. This is usually illustrated with big estimates, such as that trade misinvoicing drains $800 billion (USD) annually from developing countries, or that it is responsible for $50 billion of illicit flows from Africa.
While there are of course real legal uncertainties and enforcement failures, it is becoming clear that these issues are not well represented by adding up gaps and mismatches in trade data, which often do not reflect misinvoicing at all. Even more fundamentally it is a mischaracterisation to interpret “misinvoicing” as an example of the same kind of thing as legitimate questions over transfer pricing. On the one hand is customs fraud and smuggling, which is a channel for illicit financial flows, and on the other there are ordinary questions over determining acceptable “arms-length” prices for subsidiaries of a multinational corporations to charge between themselves.
For example, a report by Olivier Longchamp and Nathalie Perrot of the Swiss NGO Public Eye provides a good outline of how commodity price manipulation can be used as a means to enable illicit (i.e., illegal) financial flows. They map out several different arrangements between trading companies, “politically exposed persons,” and state-owned enterprises to transfer bribes and kickbacks by misreporting the value of commodity trades (the diagram below is only the simplest of a series).
It is sometimes argued that excluding legal tax planning or resulting “misalignment” from the definition of illicit financial flows means excluding multinational corporations from the scope. However, this is not true, instead it draws the line between corporations acting lawfully and acting in ways that break the law or that abet crime and corruption.
The Swiss Eye report highlights cases such as abuse of the Iraq Oil for Food program involving Glenclore, Vitol making payments to individuals close to the President of Congo-Brazzaville, Glencore (again) over-billing ore from Kazakhstan and paying commissions to a close advisor of the president, and Alcoa’s involvement in trade price manipulation in order to make side payments to a minister in Bahrein. Other cases such as Siemens historic bribe paying and Operation Car Wash in Brazil (involving many companies including Petrobras and Odebrecht) are also well known.
Another recent report The Plunder Route to Panama by the African Investigative Publishing Collective highlights how international financial centres (including London) become the end point for resources plundered through corrupt deals involving politicians and well-connected people. The South African Centre for Investigative Journalism amaBhungane has tirelessly investigated the use of manipulated contracts and misreported payments to deliver kickbacks and embezzle funds from public enterprises in South Africa. In the UK, Lord Peter Hain called for the government to seek a criminal investigation into whether HSBC and Standard Chartered banks facilitated the illicit transfers from South Africa.
There is perhaps a fear that multinational tax avoidance will fall off the international development agenda altogether if it is not included in the SDGs under target 16.4. But there is a better place for considering the tax affairs of multinational corporations in the global goals. That is under target 17.1: strengthening domestic resource mobilization. Rich countries should consider how their tax rules and treaties, the development of international tax norms, and the conduct of multinational corporations may support or undermine tax collection in developing countries.
Strengthening the consistency of international tax rules and the administration of tax law so that they are neither weakly enforced, nor capricious and predatory would be positive for citizens, businesses, and public budgets, and is good for both inward investors and host countries. Bundling everything under a weakly specified and easily sensationalised category of “illicit financial flows” undermines trust, understanding, and the ability to have constructive conversations about how to do this.
Illicit financial flows (IFFs) connected with corruption, crime, and tax evasion are an issue of increasing concern. However, there is not yet a clear consensus on how to define illicit financial flows, and even less on how to measure them.