Taking global action against illicit financial flows

The scope of the issue and how can the international community act in support of the 2030 Agenda

October 22, 2018

 

Domestic public resources are identified as fundamental for development financing. One of the ways in which countries can mobilize these resources is by increasing tax revenues, yet this remains a key challenge for some. According to the OECD, in 2015, African countries as a whole had a total tax revenue to GDP ratio of around 19%, with Latin America and Asia averaging at around 22% and 15% respectively, compared to around 34% for OECD member countries. A variety of factors affect countries’ ability to generate tax revenues, including the presence of large informal and subsistence sectors, narrow tax bases, and dependence on volatile export commodities. Domestic revenues are further undermined by tax evasion and tax avoidance. The term Illicit Financial Flows (IFFs) is often used to describe such practices.

There is no universal definition of IFFs, however such flows are commonly understood to fall into three main categories: (i) the acts themselves are illegal (e.g. corruption, smuggling and trafficking in minerals, wildlife, drugs, and people, tax evasion); (ii) the funds that stem from these activities are also illegal; and, (iii) the funds are used for illegal purposes (e.g. organized crime). Global Financial Integrity, a Washington based think-tank working on transparency in the international financial system, estimates that in 2013 US$1.1 trillion left developing countries through IFFs. GFI regards this estimate as highly conservative, as it does not pick up movements of bulk cash, the mispricing of services, or many types of money laundering. The research suggests that about 45% of illicit flows end up in offshore financial centres, and 55% in developed countries.

According to the OECD, between 2008-10, Africa alone had lost US$63.4 billion through trade mispricing and other illicit outflows; more than what it had received in aid and foreign direct investment, which amounts to US$62.2 billion over the same period. Ms. Ngozi Okonjo-Iweala, former Minister of Finance and Coordinating Minister for the Economy, Nigeria and a global advocate for the fight against malpractices in taxation says: “One of the problems developing countries have is that large corporations or evaders of tax have a lot of expertise.” Beyond reducing much-needed resources for sustainable development, IFFs undermine governance, foster corruption and facilitate transnational organized crime. The issue is therefore rightly on the international policy agenda. As such one of SDG 16 targets (to promote peaceful and inclusive societies, and accountability) is to, "significantly reduce illicit financial and arms flows, [and] strengthen the recovery and return of stolen assets and combat all forms of organized crime."

Other sources of revenue leakage include those generated by aggressive tax planning strategies, typically by multinational enterprises (MNEs). MNEs engage in highly complex strategies to shift profits from where they are earned to low or no tax jurisdictions; also known as the Base Erosion and Profit Shifting (BEPS). The problem is exacerbated by knowledge asymmetry between developed and developing countries in terms of identifying, understanding and countering these strategies. According to UNCTAD, an estimated US$100 billion of annual tax revenue losses for developing countries can be attributed to multinationals’ offshore hubs. UNCTAD also notes that MNE contributions to government revenues are around 10 percent in developing countries. Appropriate MNE taxation is central to increasing the domestic resources of developing countries so that taxes are paid where economic activity occurs and value is created.

Taking global action against illicit financial flows

While working to increase confidence in national tax systems, the international community can help strengthen the tax capacities of developing countries. Photo: MaxPixel

What can be done?

Countries could commit to set nationally-defined revenue collection targets, work to increase domestic financial transparency, address excessive tax incentives, and build their revenue collection capabilities through modernized, progressive tax systems, improved tax policy, and more efficient tax collection. This would help to increase confidence in national tax systems.

The international community meanwhile can help strengthen the tax capacities of developing countries, including through Official Development Assistance (ODA). The Addis Ababa Action Agenda pledged the doubling of aid for taxation efforts from around $222 million in 2015 to almost $450 million by 2020. A recent Oxfam report, however, concludes that donors are not on track to fulfil this promise. There has been some progress at the international level on improving transparency. International initiatives include the UNDP-OECD joint-initiative Tax Inspectors Without Borders, and on automatic exchange of tax information through initiatives as the OECD’s Global Forum on Transparency and Exchange of Information for Tax Purposes, the BEPS Action Plan and the G20 Development Working Group’s participation in the Automatic Exchange of Information (AEOI) roadmap. More can be done to tackle anonymity and build the capacities of tax administrations in developing countries, yet to tackle the subject globally, international dialogues and policy-making processes on tax matters must be inclusive and include all countries.

In September 2018, the UN Secretary-General set out a strategy at the high-level meeting on financing the 2030 agenda, with actions that the United Nations will take to help accelerate and deepen the transformation of financial systems. This represents an opportunity for countries to work collaboratively in addressing weaknesses in legal and regulatory regimes, developing common goals of fairness and transparency, and continue building an international discourse on taxation issues to increase domestic revenues and finance development.