NEW HAVEN, Conn. — The United Nations’ proposed global goals for poverty reduction miss much of the story when it comes to trade-related illicit flows — which drain tens of billions of dollars from the world’s poorest countries ever year. A new ASAP study identifies a set of simple reforms that could drastically reduce such outflows and can guide the UN’s efforts as it develops its new Sustainable Development Goals.
The UN’s Open Working Group on Sustainable Development Goals is developing a new set of targets to replace the Millennium Development Goals, which expire in 2015. The Group’s late-stage “zero draft” was released for comment June 2. It outlines some ambitious objectives, including bringing to zero the number of people living on less than $1.25 per day.
The draft also includes the objective of reducing illicit financial flows, but it does not identify any policies to be implemented in order to achieve the reduction. ASAP’s new report outlines reforms that could fill the gap.
ASAP, a global professional association whose membership includes some of the world’s top poverty researchers, has identified six of the most promising reforms through the report, which involved in-depth interviews with global experts in tax, financial governance, and development, as well as a review of the best existing research. ASAP will continue its investigation of the relative merits of these and other reforms, in consultation with over 20 relevant experts, and will deliver additional recommendations in July.
The six reforms identified in the report focus on trade-related illicit financial flows. These include tax dodging, trade misinvoicing, and corporate profit shifting. Illicit flows from developing countries alone totaled an astounding $5/9 trillion from 2002 to 2011, according to the NGO Global Financial Integrity.
“A large proportion of all international trade takes place within this or that multinational enterprise (MNE),” said Thomas Pogge, ASAP President and Leitner Professor of Philosophy and International Relations at Yale University.
“Much of this trade is designed to shift the MNE’s profits into tax havens: jurisdictions that impose low or no taxes on profits. Poor countries with limited administrative capacities find it difficult to curb such profit shifting, which drains them of capital and deprives them of tax revenues. A concerted international solution to this problem could benefit developing countries more than all the development assistance they currently receive.”
Academics Stand Against Poverty recommends that the Open Working Group on Sustainable Development Goals makes the following six reforms central to their efforts to tackle illicit financial flows.
1) Reform the arm’s-length transfer pricing system
The arm’s-length principle (ALP) holds that the price used for an intra-group transaction should match the price that would be paid between two different companies on the open market. In practice, however, subsidiaries of MNEs often charge each other non-ALP rates in order to minimize overall tax burden.
Reform should be aimed at making sure that prices are more closely linked to actual economic activity and value creation. Furthermore, the ALP system should be simplified and make more transparent, two goals the OECD and the UN Committee of Experts on International Tax Matters are currently working on.
2) Reform international accounting standards
Currently, corporations are only required to account for trade with unrelated companies and are therefore able to conceal trade between affiliates of the same company. Country-by-country reporting would require corporations to report all sales, profits, and taxes paid in all jurisdictions in their audited annual reports and tax returns. This would pose little additional administrative burden on corporations, since they already compile such audits for internal purposes. Disclosing this information could be enormously beneficial for tax authorities and make tax havens less attractive.
3) Implement universal automatic exchange of information
Automatic exchange of information is crucial for enabling tax authorities to work more effectively. In 2013, the G20 pledged to implement it among their members by 2015. This commitment to automatic exchange should be made universal in order to include developing countries.
4) Require public registers of beneficial ownership
Disclosure of beneficial ownership, meaning the natural person who is the beneficial owner of a company or an asset, is highly important for authorities to track and regulate financial flows. Requirements in this area should be expanded, including disclosure to the public, so that not just authorities but also civil society can hold companies responsible.
5) Increase the rate of stole asset repatriation
According to a World Bank report, only about $5 billion (or around 1%) of the $300-600 billion of stolen assets from the last 15 years were successfully repatriated. Increased political pressure and internationao co-operation will be necessary to achieve progress in this area. Additionally, the Stolen Asset Recovery program of the World Bank and the UN Office on Drugs and Crime should be scaled up.
6) Increase official development assistance for capacity building on matters of tax
Many developing countries lack sufficient capacity fro dealing with illicit financial flows. International efforts to address tax abuse must therefore be complemented by domestic capacity building.
OECD research has shown that the return on investment for official development assistance (ODA) targeted towards capacity building of developing countries’ tax administrations is very high; currently, however, only a minute fraction of ODA is dedicated to this purpose. Thus, the proportion of ODA dedicated to capacity building on tax matters should be scaled up.
Download the report here.