Tax in Developing Countries: Increasing Resources for Development

Written evidence submitted by Latindadd

(The Latin American Network on Debet, Development and Rights)

About us

The Latin American Network on Debt, Development and Rights ( Latindadd ) is composed of 17 organisations from 10 Latin American countries, working on issues related to debt, financing for development and tax justice. Over the last 10 years Latindadd has been conducting awareness-raising and advocacy activities, public policy monitoring, as well as providing proposals towards a fair economy, at the service of the people.

For more information on our work on tax justice, and to discuss further any of the subjects covered in this submission, please contact María José Romero, Latindadd advocacy and outreach coordinator, majo@latindadd.org.

Summary

1. We welcome the fact that the International Development Committee of the UK Parliament is conducting an inquiry into tax and development. We also welcome the growing debate around tax and development that takes place within the G20 and the European Union institutions. Political commitments on increasing financial transparency and international cooperation on tax matters, provides developing countries government and civil society organizations with the political backing to stand up to companies and non cooperative governments.

2. We do agree with the utmost importance of the link between taxation and development. As the intergovernmental organizations report to the G20 Development Working Group recognises, "taxation provides governments with the funds needed to invest in development, relieve poverty and deliver public services. It offers an antidote to aid dependence in developing countries and provides fiscal reliance and sustainability that is needed to promote growth." [1]

3. Developed countries and particularly the UK, have an important role in setting up the global rules on tax matters. Their own tax systems affect the ability of developing countries to increase tax revenues in a progressive way. Therefore, the UK government can and should contribute with the following actions:

· Follow intergovernmental organizations recommendations and undertake "spillover" analysis of tax the current corporate taxation reform.

· Take action about financial secrecy in the overseas territories, and work towards automatic exchange of information at the G20.

· Support capacity building of tax administrations in line with the Paris principles of aid effectiveness, through the DFID.

· Support Non State Actors to hold governments and companies to account for their policies and operations, through the DFID.

· Support the implementation of Country-by-Country reporting to challenge tax abuse by MNCs.

· Support for a forum where developing countries have a say in norm setting of global tax rules – ie. the UN Tax Committee.

The link between taxation and development

1. Developing an effective tax system, the state can mobilse domestic resources, redistribute wealth and provide essential services and infrastructure. In doing so, governments are likely to be more accountable to their citizens and, in turn, citizens are more likely to engage in the political process – demanding services and representation as a retribution for the taxes they pay.

2. While governments in countries that are members of the OECD tend to raise around 35 per cent of their GDP from taxes, the track record is much lower in developing countries, with an average of 18 per cent in Latin America. [2] Although revenues have increased considerably in relation to the 1990s as a result of the fight against corruption and fiscal evasion, it is still not enough to meet the needs for financing of national states and progressing towards the MDGs.

3. This picture is even worse in terms of distribution, since two thirds of the tax base fall to consumption tax and other indirect taxes, and only one third to direct taxation (personal income tax and corporate tax). That is why, according to the Economic Commission for Latin America and the Caribbean (ECLAC), "it is not surprising that revenue distribution after tax is even more inequitable than primary distribution." [3]

4. Many developing countries are affected by domestic challenges that notably limit their capacity of development. Revenue authorities are often weak and fail to collect the taxes they should and the size of the informal sector makes monitoring of economic activities and the collection of taxes a huge challenge; corruption in governments and tax authorities undermines trust and diminishes the incentives for citizens to pay tax.

5. Yet increasing the tax base is not only a matter of levying the informal sector, which is often composed of poor people that live in the informality because they cannot afford another way of living.

6. But developing countries do not always have the power to change national situations. They face pressures to adopt domestic policies that can undermine their taxing rights. Conditionalities and advice attached to grants and loans have, in the past, promoted highly regressive tax policies; tax competition pushed countries to lower tax rates and offer tax holidays in the hope of attracting foreign investment. On top of this there is a lack of accountability regarding agreements with and the operation of multinational companies (MNCs) and the taxes they pay. The latter problems are exacerbated by financial secrecy and limited international cooperation in tax matters, which undermines the ability of developing countries to raise revenues. Finally, the lack of participation of developing countries in (or indeed their direct exclusion from) international tax matters, makes the things even worse.

7. All too often global tax rules and developed countries decisions on their own tax system affect developing countries’ ability to increase tax revenues in a progressive way.

Tax dodging by private individuals and companies

8. According to Global Financial Integrity, a think tank based in Washington, developing countries lost an average of USD 725 billion to USD 810 billion per year in 2000-2008 due to illicit financial flows. Estimates also indicate that the capital flight curve continued to grow (at a 12% annual rate) despite the crisis. A great amount of this money went out from Latin America, where Mexico and Venezuela are among the top ten looser countries, amounting USD 410 billion and USD 157 billion respectively.

9. The greatest part of illicit financial flows does not result from corruption of criminal activities. Actually, two thirds are connected with business flows, that is to say, tax evasion and avoidance by multinational companies.

10. As shown by Christian Aid, a UK-based NGO, developing countries lose out on an estimated USD 160 billion each year as a result of false invoicing and transfer mispricing practices. This amount is more than one-and-a-half times the combined budgets of the whole rich world in 2007. [4]

11. Christian Aid also estimated that in 2005-2007, approximately USD 95 billion were transferred from Latin America as a result of undervalued trading of commodities. This capital would have generated, if properly declared, USD 31 billion additional taxes for the countries of the region.

12. Additionally, a recent report by the European Network on Debt and Development (Eurodad) [5] exposes both legal and illegal methods through which MNCs manage to avoid and evade paying taxes from developing countries.

13. Among other strategies, companies often use tax havens as a base for corporate activity, holding companies, location of intangible assets, such as intellectual property or copyrights and trademarks, as well as transfer of debts and thin capitalization. One of the most illustrative examples of the use of these jurisdictions is the one known as "the bananas case", reported by the British newspaper the Guardian in 2007. In this case, while the actual exported product went directly from Latin America to the UK, on "papers" they went through seven previous destinations – by crossing the Atlantic Ocean both ways several times – such as the Cayman Islands, Luxembourg, Isle of Man and the Bermuda Islands. All this virtual travel caused bananas, for instance, to exit Guatemala at USD 0.25 per kilo and be sold in international markets at USD 0.80.

14. Eurodad's report also illustrates how financial reporting on a country-by-country basis could enhance the capacity of civil society to hold MNCs to account for their abusive operations and to hold local governments to account for their revenue mobilisation and spending.

15. The problem of tax dodging is also closely related to weak tax administration, due to the meagre resources of national States and the difficulty to access reliable information on the activities of private individuals and MNCs. This causes huge problems to enforce national tax legislation and to promote well extended tax literacy. In some cases MNCs have an economic capacity equivalent to the GDP of the receiving countries, which hinders the bargaining power of national governments.

How should the UK do to support developing countries’ efforts?

16. In the last two years, G20 leaders have expressed concerns about the lack of transparency of and cooperation from secrecy jurisdictions and the need to regulate them. The fight against non-cooperative jurisdictions took special relevance during the UK presidency of the group. In the London Summit in April 2009 [6] , the world leaders publicly declared that "the era of the banking secrecy is over" and announced a number of important steps to combat tax havens. Yet the reality is that tax haven secrecy is alive and well. Action is required to ensure that financial secrecy (including that in UK crown dependencies and overseas territories) is addressed through multilateral agreements to enshrine automatic exchange of information.

17. At the EU level, where the UK also plays a key role, European governments also stressed the same line of actions. At the Council Summit in June 2010, they committed to "push for a more development-friendly international framework" in order to address tax evasion and harmful tax practices, and to increase cooperation and transparency. [7]

18. At the country level, different state agencies of the UK government, such as the UK Treasury, the Department For International Development (DFID) and the HM Revenues & Customs, take forward activities that have a direct or indirect impact on the capacity of developing countries to mobilise domestic resources. However, policy coherence for development is not always present in each and every decision taken by these bodies.

19. It is worth noting that the report to the G20 by the IMF, World Bank, OECD and the UN included the following recommendation: "It would be appropriate for G20 countries to undertake ’spillover analyses’ of any proposed changes to their tax systems that may have a significant impact on the fiscal circumstances of developing countries…in moving, for instance, from residence to territorial systems." [8]

20. In this regards, the committee should be aware of the potential development impact of the reform of corporate taxation that the government is currently undertaking. The core of this reform is to move from a residence tax system to a more territorial system, under which overseas earnings are exempt from UK tax. Whereas this reform would give MNCs a GBP 840 million tax break, by relaxing the very rules designed to prevent tax-haven abuse, [9] Action Aid International has estimated that the reform may cost developing countries as much as GBP 4 billion. [10] This is a huge amount of money that an in-depth "spillover analysis" may reflect.

21. In line with previous commitments and policy coherence for development, the UK government should consider the following recommendations:

· The UK government should follow intergovernmental organizations recommendations and undertake "spillover" analysis of tax policy changes.

· The UK should take action regarding financial secrecy in the overseas territories, and work towards agreements which enshrine automatic exchange of information at the G20.

· DFID should support capacity building of tax administrations in line with the Paris principles of aid effectiveness and work with HMRC on technical assistance, reporting all of the government's work on this issue.

· DFID should support Non State Actors to hold governments and companies to account for their policies and operations.

· The UK should support the implementation of Country-by-Country reporting to challenge tax abuse by MNCs.

· The UK should support for a forum where developing countries have a say in norm setting of global tax rules – ie. the UN Tax Committee.

February 2012