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Tax in Developing Countries: Increasing Resources for Development

Written evidence submitted by Global Financial Integrity (GFI)

Introduction to Global Financial Integrity

1. Global Financial Integrity (GFI) is a Washington, DC-based research and advocacy organization that promotes national and multilateral policies, safeguards, and agreements aimed at curtailing the cross-border flow of illicit capital. By conducting groundbreaking research, working directly with governments, putting forward solutions, and facilitating strategic partnerships, GFI is leading the way in efforts to promote financial transparency, maximize resources for development, and enhance global prosperity and security.

2. GFI was launched in mid-2006 with the goal of promoting financial transparency as a way to curtail the flood of illicit money out of developing economies and to hamper money laundering, tax evasion and terrorist financing. Opacity in the financial system, which is perpetuated through the use of secret bank accounts, fraudulent foundations, disguised corporations, anonymous trusts, falsified pricing and other mechanisms, facilitates all manner of illegal activities. Further, this secrecy has a tremendously corrosive effect on economic development and poverty alleviation efforts as well as on attempts to curb narcotics trafficking and ensure national security.

3. The adverse impact of the shadow financial system and the focus of GFI’s mission are seen most readily in the area of poverty alleviation. From our research we estimate that more than $1 trillion in funds that are illegally earned, transferred or utilized are spirited out of developing countries annually. This illicit flow of capital constitutes the most damaging economic condition hurting the poor. Indeed, for every $1.00 of Official Development Assistance (ODA) flowing into developing countries, approximately $10.00 in illicit funds flow out of those economies. That is not to say that ODA has no actual impact or that ODA is entering a country and then flowing out-on the contrary-there is no causal link between the two. We highlight the figures conjunctively to demonstrate that ten times more positive development could be achieved if a country was able to capture that additional $10 that is leaving the economy in the form of illicit capital flight.

4. Illicit capital outflows drain hard currency from developing economies, reduce tax collection, forestall investment and undermine trade. The multiplier effect of this situation is that domestic resources for development are lacking and the impact on social programs is staggering. Health, housing, nutrition and education all suffer while crime and corruption run rampant. The end result is that the poorest and most vulnerable people in society suffer from fewer economic opportunities and growing inequality.

5. The $1 trillion that exits developing economies each year must be seen as hidden resources for development that simply need to be marshaled. Those funds represent both the untapped potential of poor countries and the path to an enhanced business climate, economic growth, and stronger democratic institutions. Indeed, more transparency in the global financial system will protect and increase investment capital by creating strong economies that foster stable governments.

6. GFI’s economic reports include (i) Mexico: Illicit Financial Flows, Macroeconomic Imbalances, and the Underground Economy, D. Kar (2012); (ii) Illicit Financial Flows from Developing Countries Over the Decade Ending 2009, D. Kar & S. Freitas (2011); (iii) Illicit Financial Flows from the Least Developed Countries: 1990-2008, D. Kar (2011) (commissioned by the United Nations Development Program); (iv) Transnational Crime in the Developing World, J. Haken (2011); (v) Illicit Financial Flows from Developing Countries: 2000-2009, D. Kar & K. Curcio (2011); (vi) The Drivers and Dynamics of Illicit Financial Flows from India: 1948-2008, D. Kar (2010); (vii) The Absorption of Illicit Financial Flows from Developing Countries: 2002-2006, D. Kar, D. Cartwright-Smith & A. Hollingshead (2010); (viii) Illicit Financial Flows from Africa: Hidden Resources for Development, D. Kar & D. Cartwright-Smith (2010); (ix) Privately Held, Non-Resident Deposits in Secrecy Jurisdictions, A. Hollingshead (2010); (x) The Implied Tax Revenue Loss from Trade Mispricing, A. Hollingshead (2010); (xi) Illicit Financial Flows from Developing Countries: 2002-2006, D. Kar & D. Cartwright-Smith (2008). All reports can be found at

Responses to Specified Topics

1.      How can DFID better support developing countries to improve revenue collection?

7. The first step DFID must take in its effort to help developing countries improve their revenue collection is to coordinate with governments and multilateral institutions that are already working on tax collection issues. By doing this DFID will be able to learn from best practices and will not duplicate efforts already implemented by other governments or institutions. Participation in the International Tax Compact (ITC) may prove helpful in that regard. The ITC is, according to its website,

"an initiative to strengthen international cooperation with developing and transition countries to fight tax evasion and avoidance. Launched by the German Federal Ministry for Economic Cooperation and Development (BMZ), the ITC aims at promoting tax systems that allow partner countries to be more effective in fighting tax evasion and inappropriate tax practices with the intention to achieve national and international development goals. As an informal platform of bi- and multilateral development partners, the ITC aims at promoting tax systems that allow developing countries as well as transition economies to be more effective in fighting tax evasion and inappropriate tax practices."

8. At the last ITC workshop in Bonn in September 2011, which was titled "How to Operationalize the International Tax and Development Agenda," there were no UK government representatives present according to the participant list ( 2011-09-19_itc_Participants-list_Governmental-workshop.pdf ). However, four representat ive s from the Zambian government attended the meeting. Considering the International Development Committee’s intended focus on Zambia as a case study, DFID representation at the ITC event could have proven beneficial. a

9. For a more specific course of action, we suggest DFID examine the possibility of addressing Zambia’s customs department procedures. According to new research by Global Financial Integrity, Zambia lost over $4 billion in illicit financial flows from 2003 - 2009 due to the mispricing of trade (this amount is roughly equal to its current external debt). Curtailing the amount of mispriced trade entering and leaving the country will add capital to the economy as a whole and, if the goods are taxed properly, will add revenue to government coffers. Global Financial Integrity has expertise in how mispriced trade shipments can be detected and is willing to cooperate with DFID in this area.

10. Additional steps could include coordination with other organizations with technical expertise working in the tax space. For example, DFID could fund technical assistance from the IMF Fiscal Affairs Department focusing on how to improve revenue collection in specific developing countries. Alternatively, or in addition, DFID could fund technical assistance through the IMF’s Fiscal Affairs Department that focuses on comprehensive tax reform in order to boost tax collection and improve its efficiency and equity.


2.      How can DFID support developing countries to use the revenue base responsibly in order to improve service delivery and development outcomes?


11. Service delivery is outside the mission of Global Financial Integrity so we will refrain from commenting on this question.


3.      Tax evasion and avoidance in developing countries by private individuals and companies


12. There are several steps DFID can take to address tax evasion and avoidance in developing countries which include country-specific efforts as well as policy positions DFID can promote within the UK government to make tax evasion far more difficult.

13. Within a developing country, DFID can examine the technological capability as well as the capacity of the existing tax authority to determine areas where improvements can be made. As was noted in the answer to question #1, it would be helpful to first interact with the ITC and query other institutions, such as the IMF’s Fiscal Affairs Department, to determine what work is being undertaken at the present time in this area in order to determine what value added DFID can bring to the issue.

14. Within the UK government, DFID can advocate for policies that will make it difficult for tax evaders, whether private individuals or governments, to hid money from relevant tax authorities. Three policies, Automatic Tax Information Exchange, Beneficial Ownership registries , and Country -by-Country reporting for multi national corporations are key measures to curtail tax evasion and avoidance.

15. Automatic Tax Information Exchange would require governments to collect from financial institutions data on income, gains, and property paid to non-resident individuals, corporations, and trusts. That data would be collected automatically and provided to the governments where the non-resident person or entity is located. This is similar to the Savings Tax Directive now in place within the European Union , but the intention is to create a global standard to greatly limit the ability of people and companies to avoid or evade taxes in their home country by hiding funds in another jurisdiction.

16. A Beneficial Ownership provision would have two prongs, action by the state and action by the financial institutions. Regarding state action, it would require that the beneficial ownership, control and accounts of companies, trusts and foundations be readily available on public record to facilitate effective due diligence. With respect to financial institutions, this provision would explicitly require that financial institutions identify the ultimate beneficial owners or controllers of any company, trust or foundation seeking to open an account. Millions of companies exist worldwide and the beneficial owner of the firm is completely unknown; tax authorities and law enforcement agencies have no way of knowing who controls the company. This opacity makes it relatively easy to evade or avoid taxes, among other illicit activity. The importance of beneficial ownership is gaining recognition in many quarters and none more so than in the United States. In September the Obama administration announced that one of the eight pillars of its Open Government Partnership Action Plan would be that information regarding the beneficial ownership of companies, trusts and foundations should be collected by the government and made available to law enforcement.

17. Further, country-by-country reporting would require that all multi-national corporations report sales, profits, and taxes paid in all jurisdictions in their audited annual reports and tax returns. Tax avoidance is facilitated by tax haven structures created to shroud business activity in secrecy. It is often impossible for tax authorities to obtain information or assistance from the government of a tax haven, and companies are not usually under any obligation to disclose what they are doing outside the country that is making the enquiry. Given this opacity, even proving the existence of a tax avoidance scheme can be difficult. The European Parliament has already urged the International Accounting Standards Board to move beyond voluntary guidelines and support the development of an appropriate accounting standard requiring country-by-country reporting by extractive companies. While this measure is a sound first step, it is not far-reaching enough.

18. Individuals and companies in developing countries can use various mechanisms and entities to hide and launder money in other jurisdictions in order to avoid and evade paying taxes where legally required. DFID, as part of its effort to promote development and reduce poverty in developing countries, should become an advocate for the implementation in the UK of the measures noted here. This is the key reason that the development and tax justice communities were so disappointed with last year’s decision by the UK Government to agree to a treaty with the Swiss Government resulting in the withholding and remittance of tax due from accounts held by British citizens in Switzerland instead of providing the government with information about the British persons holding such accounts; it perpetuated and condoned the destructive practice of obstructive bank secrecy. Additionally, DFID should also call on the UK government to push for these same efforts within the G20 process so that they become global standards.

4.      How effective are international efforts to promote tax disclosure and transparency likely to be


19. International efforts to promote tax disclosure and transparency like the Double Taxation Treaties (DTTs) and Tax Information Exchange Agreements (TIEAs) have helped to lead the fight against tax evasion and avoidance. However, Global Financial Integrity and others question the effectiveness of the current OECD model TIEA which requires that tax information be exchanged between countries upon request because the information-gathering process itself is burdensome.  The standard TIEA requires the requesting party to provide very specific details about the information being sought, which is a very high burden.  Moreover, tax havens interpret the OECD guidelines very narrowly , and they rely on bank secrecy laws to delay or circumvent compliance with their TIEA obligations.

20. A more efficient model, the exchange of tax information on an automatic basis (often called "automatic exchange of information"), exists between certain countries with respect to some tax related information, but is neither widely used nor the international standard that countries are encouraged to embrace by the OECD. The OECD Secretariat has developed both technical guidance and case studies for the use of automatic exchange of information, but the OECD Members have elected exchange upon request as the accepted international standard. As such, the more efficient and effective model of automatic exchange of information has been sidelined as a result of a lack of political will by OECD Members.

21. In addition, the bilateral TIEA/DTT approach requires countries to negotiate and approve numerous treaties, a slow and laborious process just to get agreements in place. Some efforts have been made, with the support of the UK, to create a multilateral TIEA based on the OECD information upon request model. This approach is a step in the right direction but still does not address the limitations inherent in agreements to exchange tax information upon request, as discussed above.


5.      Capital flight and its implications for developing countries


22. The issue of capital flight, or illicit financial flows, and its adverse impact on development is a concept that has become well understood and embraced by the development community over the past few years. Indeed, in May 2011 the head of the UN Development Program Helen Clark underscored the importance of addressing illicit flows saying, "discussions about illicit financial flows need to be placed within the broader context of how to get enough sustainable funding for development ." She also noted "the worrying reality is that illicit financial flows undermine human development, especially in those countries where development funding is most sorely needed."

23. Moreover, the final communiqué at the G20 Summit in Cannes in November 2012 noted that "Illicit capital flows hamper growth potential and also affect domestic resource mobilization. These flows are facilitated by weak tax systems, particularly at risk to abusive tax practices and non-cooperative jurisdictions. Addressing these challenges requires joint efforts from both developed and developing countries." Additionally, the issue of illicit flows was a focus at the Fourth High-Level Form on Aid Effectiveness in Busan, South Korea last December. In the conference’s final statement the governments noted that they would "accelerate [their] individual efforts to combat illicit financial flows . . . ." due to their corrosive impact on economic growth.

24. Illicit financial flows sap private investment capital, deplete national savings and undermine economic growth. Capital flight also robs national tax authorities of much-needed resources to sustain social transfers for poverty alleviation or to meet the Millennium Development Goals. There is also some evidence that by expanding the gap between domestic savings and investment, capital flight has led to an increase in external debt.  The so-called revolving door effect between external debt and capital flight raises questions about debt sustainability in the long run and the overall effectiveness of aid.

25. Finally, capital flight worsens the distribution of income by allowing the rich and the powerful to amass great wealth in a clandestine manner and typically without paying their fair share of national taxes , which leads to a narrowing of the tax base and increased tax burden on the lower income groups. Meanwhile, unemployment rates remain high in many poor developing countries that cannot generate enough capital for investment and economic growth.

26. Capital flight perpetuates poverty, and poverty is inherently destabilizing both geopolitically and with respect to global economics. Regions plagued by poverty are often breeding grounds for insurgence and civil war, where ordinary people fight to obtain or control scarce resources. Geopolitical instability affects key commodity prices and can significantly increase the cost to private enterprise of doing business in certain regions of the world. Capital flight is not only about poverty-it is also about global markets and national security. As a result, its eradication should be the subject of a multifaceted, coordinated approach.

27. This should be a compelling reason for DFID to engage with developing country governments and within its own government to implement measures to make tax evasion and avoidance as difficult and cumbersome a process as possible.

February 2012

Prepared 22nd February 2012