The political economy of illicit financial flows
In this blog series, our experts share their thoughts and lessons learned on key financing for development issues, in the run-up to the UN’s Financing for Development conference in July.
Tax evasion has often been the hallmark of the elites. In ancient Rome, the upper class viewed tax as ‘the mark of bondage.’ Two millennia later, Leona Helmsley, the wife of a real estate billionaire in New York, reportedly said: ‘Only little people pay taxes’.
But the Roman Empire collapsed because the tax on land was largely passed on the poor, and later on the middle classes, while the elite carried less and less of the public financial burden.
Today, both developed and developing countries alike face similar problems. Illicit Financial Flows (IFFs) such as tax avoidance and evasion, embezzlement of national resources, trade misinvoicing, and smuggling of goods and capital across borders, are widespread phenomena and occur for a range of reasons, including theft, corruption, high political or economic instability in the originating country or higher returns on investment in the destination country.
Although these problems can affect all countries, it can be particularly prevalent (and harmful) in natural resource-rich states with weak governance such as Nigeria, Gabon and Equatorial Guinea. A 2010 study by the African Development Bank (PDF) suggests that, between 1980 and 2009, total illicit financial outflows from Africa grew by 11.9 percent per year, outpacing official development assistance entering the region. The problem is not specific to Africa: In UNDP’s 2011 report on illicit financial flows from the Least Developed Countries (LDCs), we found that the ratio of illicit financial flows to GDP averaged about 4.8 percent for LDCs as a whole.
Progress in tackling the problem has been slow, in part because IFFs often benefit powerful vested interests. Political capacity to act is constrained where counter-measures require the support of those same elites who are also significant beneficiaries of IFFs. Can this conundrum be solved?
Control of IFFs requires two conditions to apply: an effective state with the capability and determination to address the problem; and ‘veto-holding’ elites that will not block reform. One of the most successful examples in the last fifty years is the administrative state of Singapore. Their concept of ‘public service excellence’ is the product of the elite’s buy-in for the state to enforce public authority fairly, effectively and efficiently. The capacity to work in the collective interest, with elites as well as states constrained by political accountability and by the rule of law, leads to greater public trust in the institutions and strengthens their capacity to govern. Conversely, failings in governance lead to a ‘vicious cycle’ of IFFs, worsening public service and weakening public authority.
Tackling IFFs today is shaped by whether those with money, power and influence play by the same rule as everyone else. Elite ‘free-riding’ (through IFFs, tax evasion, avoidance and exemptions) can only be effectively addressed if and when elites share a political conviction in their own and the country’s long-term future.
The Third International Conference on Financing for Development taking place in Addis Ababa in July provides an opportunity to make progress on this important agenda. Proposals tabled so far include policy innovations such as public country-by-country reporting by multinational enterprises, automatic exchanges of tax information between countries and creating an intergovernmental committee on tax cooperation. More effectively curtailing IFFs promises substantial sustainable development dividends.