Offshore Financial Centres - Treasury Contents


Memorandum from Christian Aid

EXECUTIVE SUMMARY

  Christian Aid works in nearly 50 developing countries worldwide, supporting local organisations to deliver urgently needed services directly to poor communities, and to scrutinise and hold their own governments and the international community to account.

  Finance is fundamental to development, since without sustainable revenue for governments there is no prospect for sustained, independent development. Poorer countries typically have revenues around 10-15% of GDP, compared to more than 40% in the UK. Taxation is also at the heart of citizen-state relations, and has been shown to significantly strengthen channels of political representation.

  There are many different obstacles to effective taxation systems, and Christian Aid is increasingly working with partners to address these domestically where possible. Even absolute success domestically would not come close to a solution, however—because the international financial system as it stands represents an insurmountable barrier to effective taxation in developing countries. The role of offshore financial centres (OFCs) is central to this, and therefore we welcome both the fact that the committee is to examine OFCs, and also the opportunity to make this submission.

  Our submission will focus on the role that OFCs play in preventing the international transparency that developing countries need in order to prevent corruption and to ensure their taxation systems are effective, and on measures that the Treasury could take to reduce the damage done by OFCs. OFCs provide opacity to international flows of capital, which prevents developing countries from taxing wealthy individuals and businesses where appropriate, and from taking steps to prevent grand corruption.

  Christian Aid has estimated that one form of corporate tax evasion alone (via trade mis-pricing) is responsible for a revenue loss to developing countries of around $160 billion a year—more than one and a half times total aid flows. The World Bank quotes estimates of illicit capital outflows from developing countries of $500-$800 billion annually, of which 3% relates to corruption and bribery and 60-65% to commercial tax evasion.

  Since the UK has a substantial role in, and historic responsibility for, the system of OFCs, this means that the UK is responsible for taking with one hand (via facilitating corruption and tax evasion) what it gives with the other hand (as aid). Estimates of the scale of the former strongly imply that developing countries are net losers from this arrangement. It also follows that the money of the UK taxpayer is not being spent effectively for development.

OUR RECOMMENDATIONS FOR THE UK GOVERNMENT ARE AS FOLLOWS

  We welcome DFID's existing support for the capacity of tax authorities and of civil society groups to hold governments to account on taxation issues, and hope that the latter in particular can be scaled up and given greater priority.

  We also welcome Treasury's recent statements about the need for "strong co-operation and exchange of information between Governments and tax authorities around the world", and look forward to concrete actions. We make the following recommendations.

  First, the UK government must lead multilateral efforts to ensure automatic exchange of information between jurisdictions—since exchange of information on request only is manifestly insufficient to address the problem.

  Second, the UK government should call on the International Accounting Standards Board to prepare an accounting standard on country-by-country financial reporting—which would provide the other element of transparency necessary.

INTRODUCTION

  1.  Christian Aid's mission is to challenge and change the structures that keep poor men and women marginalised, and this motivates our deep concern with the role of offshore financial centres. From a development perspective, offshore financial centres (OFCs) represent a significant obstacle to effective taxation.[271]

  2.  There are many legitimate concerns about the impact of OFCs beyond that on developing countries. The members of the Tax Justice Network (a Christian Aid partner) have recognised international expertise in this area, and their submission sets out a broader range of concerns. We do not duplicate here their technical analysis of the functioning of OFCs, but instead highlight key areas in which OFCs undermine development specifically.

  3.  Leading academics, such as Prof E.V.K. FitzGerald (Director of the Department of International Development at the University of Oxford) have also made submissions highlighting important development concerns.

  4.  From Christian Aid's perspective, and given our emphasis on the structures that maintain global poverty, the role of OFCs is most important in relation to two particular areas: the international nature of corruption, and—which is not unrelated—the ability of developing countries to create effective taxation systems.

THE INTERNATIONAL NATURE OF CORRUPTION

  5.  Corruption is a global phenomenon, and one that hinders development at many levels. Petty corruption can require poor people to pay bribes out of incomes that are already insufficient to meet their basic needs, and can also undermine their ability to obtain goods and services—or political representation—from the state.

  6.  Grand corruption is decidedly international in its character. The World Bank cites estimates that corruption and the bribery of public officials is responsible for illicit capital outflows from developing countries of $15-24 billion a year.[272]

  7.  These outflows, that deprive developing countries of much needed funds for development, do not occur in a vacuum. Often, the money reflects illicit payments by companies involved in bidding for large public contracts. Whatever its origin, as it leaves developing countries it is channelled through banks and other financial institutions, with the assistance of a range of finance professionals from accountants to lawyers.

  8.  Corruption is not therefore a problem of developing countries alone—the responsibility for facilitating corruption, for handling the proceeds of illegal actions, also rests firmly in certain industries in rich countries.

  9.  The secrecy provided by OFCs (or secrecy jurisdictions) is important to the process, since it is typically this that prevents greater visibility to those in the countries which suffer the corrupt outflows. The World Bank's Stolen Asset Recovery Initiative, which we commend, is aimed at addressing this problem, by tracking down the proceeds of corruption, through complex layers of financial transactions that occur not in poorer countries but in the financial systems of rich countries and in OFCs in particular.

  10.  However, the share of illicit capital outflows from developing countries is dwarfed by the estimated value due to commercial tax evasion—which Christian Aid also sees as fundamentally corrupt, since it is illegal and directly undermines the functioning of the state. The same analysis that finds corruption and bribery of public officials to be responsible for $15-24 billion of outflows a year, indicates that commercial tax evasion results in outflows of $300-$500 billion a year.

THE IMPORTANCE OF TAXATION

  11.  The importance of effective taxation for developing countries is increasingly widely recognised. Taxation contributes to development through the "four Rs".[273]

  12.  Revenues. Most obviously, tax is necessary to provide developing country governments with sufficient revenues to deliver basic services to their citizens. In low-income countries, and even in many middle-income countries, tax revenues are often less than or close to 10% of GDP, compared to around 40% in the richest like the UK. One definition of a fragile state—ie one that cannot or will not meet its citizens' needs—is simply of having revenue below 15% of GDP.[274] The alternative to states with the revenue capacity to deliver development is the vacuum of power (and of development opportunities for citizens) that is seen in conflict countries.

  13.  To meet the Millennium Development Goals by the target date of 2015, the World Bank has estimated that an extra $40-$60 billion a year of development finance would be necessary. Given the lack of progress in many countries thus far, and the failure of the international community to deliver on aid commitments, this now seems to substantially under-estimate the problem. Ultimately, the only sustainable source of development finance is domestic tax revenues (as emphasised in the Monterrey Consensus)—and this is also the only exit strategy from aid. It is vital then that development efforts by donors, including the UK, are geared towards building effective taxation systems.

  14.  Redistribution. Taxation is also the tool by which states can address inequalities that exist, or that arise from eg the liberalisation of trade or of financial markets. Market incomes in much of Latin America, for example, are characterised by similar inequality to that seen in the richer OECD countries. The difference is that post-tax inequality in the latter is much lower, because tax systems are capable of delivering redistribution. It is estimated that the poorest people in Brazil spend more than a quarter of their income on VAT, compared to less than 10% for the richest.[275] Only recently has the government been able to mobilise sufficient revenue to start a programme of targeted cash transfers to help the poorest—and most developing countries are poorer than Brazil and simply lack that capacity.

  15.  Re-pricing. Tax systems also play the role of ensuring that the private costs and benefits of production and consumption decisions are aligned with the social costs and benefits. For example, the UK places a high tax burden on tobacco and on petrol, because of the health and environmental damage, respectively, that these cause. This can lead—for example—to a competitive race to the bottom in which polluting industries are concentrated in poor countries with weak tax systems, since the social costs of their production may not be effectively costed there.

  16.  A broader international concern should be the ability of developing countries to deliver on commitments that are likely to be required under the UN Framework on Climate Change Convention negotiations. If the agreement due to be reached in 2010 is to be effective in cutting global emissions, then governments in every country must be able to pass on appropriate incentives to their households and businesses—and that will only happen through taxation.

  17.  Representation. Finally, and perhaps most importantly, taxation is the fundamental link between states and citizens. Research shows that effective, non-coercive taxation is what drives citizens to hold governments to account for their expenditures and thereby improves governance and promotes political representation.[276] Analysis of historical data for many countries shows that the share of tax revenues on government expenditure is systematically associated with democratisation,[277] and direct taxation (tax on income and profits) is most important.[278]

  18.  DFID has taken positive steps to help build the capacity of developing countries' tax revenue authorities, and we welcome this where it reflects the demands of those countries.[279] In particular, this must move beyond the "tax consensus" which has dominated the thinking of aid donors for more than two decades, but consistently failed to yield benefits in terms of the four Rs. More recently, DFID have shown interest in building civil society capacity to hold their governments to account for taxation decisions, and we strongly welcome this.

THE DEVELOPMENT DAMAGE DONE BY OFCS

  19.  Improvements in developing countries, however, are completely insufficient to deliver effective taxation. This is because of the large scale of tax evasion that occurs through the international system, over which developing countries have little control. At the heart of the problem is a lack of transparency. This prevents developing countries from raising the appropriate level of revenues, since taxable income streams that arise within their jurisdiction are hidden in OFCs and beyond.

  20.  This creates a fundamental inconsistency in UK government policy. On the one hand, UK taxpayers provide substantial sums to be used as aid. Much of this is provided as budgetary support to developing country governments. On the other hand, the international structure of OFCs is responsible for directly undermining the revenues of those governments.

  21.  Since the UK has a substantial role in, and historic responsibility for, the system of OFCs, this means that the UK is responsible for taking with one hand (via facilitating corruption and tax evasion) what it gives with the other hand (as aid). Estimates of the scale of the former strongly imply that developing countries are net losers from this arrangement.

  22.  It also follows that the money of the UK taxpayer is not being effectively spent to support development, since this incoherence of broader policy on OFCs and international financial regulation undermines the value of the aid given.

  23.  Transparency is required in two main areas—first, in the financial accounts of multinational companies, which are able to shift profits out of developing countries and hence reduce their tax liabilities there. Christian Aid has estimated that one form of tax evasion alone—that which occurs through the mis-pricing of trade, including abusive transfer pricing by multinational companies—is responsible for $160 billion a year in lost revenues to developing countries. This value far exceeds the total flow of aid, and could potentially deliver the Millennium Development Goals (two to four times over, if the World Bank estimates are used as a basis). On conservative estimates, allowing for existing levels of corruption and inefficiency in public expenditure, and for existing patterns of allocation of public expenditure, those revenues would—among other things—save the lives of almost 1,000 children under five in developing countries, every day.[280]

  24.  The other key area in which transparency is lacking is through the offshore financial centres. As the revelations from Liechtenstein earlier this year showed, EU countries like the UK have been unable to effectively tax their citizens because of the secrecy provided by such jurisdictions. Even a revenue authority as well resourced as HMRC is relatively powerless against the barrier of secrecy. Last month, a Treasury official made just this point:

  25.  "There is a strong economic and social case for strong co-operation and exchange of information between governments and tax authorities around the globe, and particularly within the EU, in order to meet the challenges being posed by globalisation, not just for economies as a whole, but also specifically for national tax systems.".[281]

  26.  In effect, the statement highlights the problems of retaining national tax sovereignty in light of the ease of international financial flows and the secrecy provided by some jurisdictions. This analysis applies much more deeply to poorer countries, where the capacity to trace the income streams of individuals or businesses, especially international ones, is much more limited. The need for additional revenues—to provide basic services to citizens and to invest in infrastructure to support growth and broader development aims—is also much clearer in the poorest countries.

  27.  Information exchange between jurisdictions on request has not been effective—since it has not been possible generally for the revenue authority of poorer countries to provide sufficient information to OFCs for the latter to deliver the corresponding data.

  28.  Only automatic (and comprehensive) exchange of information between all jurisdictions can ultimately enable developing countries to levy the appropriate amount of tax on the income and profits earned there. There are certainly capacity constraints to how that information could be used if it were provided tomorrow—but without any prospect of receiving that information, there is of course no incentive for countries to invest in the relevant capacity. The first step is to ensure that the information is available.

OUR RECOMMENDATIONS TO THE UK GOVERNMENT

  29.  The secrecy provided by OFCs is a fundamental obstacle to effective taxation, and to the prevention of grand corruption, in developing countries. As such, OFCs play an important role in the international structure that restricts the opportunities for development and escape from poverty of poor men and women in those countries. The UK government must confirm its commitment to development, and the coherence of its policies, by ensuring that it acts to address the damage done by OFCs.

  30.  We welcome DFID's existing support for the capacity of tax authorities and of civil society groups to hold governments to account on taxation issues, and hope that the latter in particular can be scaled up and given greater priority.

  31.  We also welcome Treasury's recent statements about the need for "strong co-operation and exchange of information between Governments and tax authorities around the world". We now look forward to concrete steps to support this sentiment and to ensure policy coherence with DFID. We make the following recommendations to ensure the tax transparency that will benefit developing and developed countries alike.

  32.  The UK government must lend its support to multilateral efforts to ensure automatic exchange of information between jurisdictions—since exchange of information on request only is manifestly insufficient to address the problem. The UK is uniquely well placed to lead on this, because of its historic responsibility and great influence over the Crown Dependencies and Overseas Territories which are such important OFCs, and because of the importance of the City of London as a global financial market.

  33.  Finally, the UK government should address the other main aspect of international financial opacity that undermines development by allowing multinational companies to avoid and sometimes evade taxation in poorer countries. The first step is to call on the International Accounting Standards Board to prepare an accounting standard on country-by-country financial reporting.

June 2008
















271   This analysis draws extensively on our May, 2008 report, Death and Taxes: The true toll of tax dodging, which is available via our website: http://www.christian-aid.org.uk/. Back

272   Baker, R., 2005, Capitalism's Achilles Heel, Wiley: London. Back

273   Cobham, A., 2005, "Tax evasion, tax avoidance and development finance", Queen Elizabeth House (University of Oxford) Working Paper 129. Back

274   Stewart, F., G. Brown and A. Cobham (forthcoming, 2008) "The distributional implications of fiscal policies in post-conflict countries," CRISE (University of Oxford) Working PaperBack

275   Quak, E.-J., 2007, "Money on the move", The Broker, quoting UNAFISCO, Brazil. Back

276   Moore, M., 2007 "How does taxation affect the quality of governance?", Tax Notes International (2 July); and Brautigam, D., M. Moore and O.-H. Fjeldstad (eds.), Taxation and State-building in Developing Countries, Cambridge University Press: Cambridge. Back

277   Ross, M., 2004, "Does taxation lead to representation?", mimeo., Dept of Political Science, University of California. Back

278   Mahon, J., 2005, "Liberal states and fiscal contracts: Aspects of the political economy of public finance", paper presented at the annual meeting of the American Political Science Association. Back

279   DFID (2006), White Paper: Making governance work for the poor, HMSO: London. Back

280   Christian Aid, 2008, Death and Taxes: The true toll of tax dodgingBack

281   Robertson, J., "The challenge of globalisation for tax policy in the EU", presentation given at conference on "Harmonizacja czy koordynacja-przyszlos«c« podatko«w w Unii Europejskiej", Warsaw, 15 May 2008. Back


 
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