The Panama Papers provide a glimpse into the netherworld of offshore finance. Many wealthy companies and individuals enrich themselves through secret dirty deals with dictators, terrorists, traffickers and other criminals or dodge taxes on their profits or investment income. Such unjust behaviour has serious economic and political consequences in the affluent West. In the developing world, the effects are catastrophic.
States can sustainably safeguard the rights and needs of their people only if they have competent and well-resourced governments that can be held accountable by the citizens. Poor countries often lack the necessary resources. This is partly due to their low standard of living: India has only about 3% of the U.S. average income, Cambodia 2%, Ethiopia 1%. It is also due to their low tax revenues of approximately 8-15% of national income compared to over 40% in the OECD countries.
While approximately 2% of North American private assets are hidden abroad, this percentage in Africa, the Middle East and Latin America is around 30%. In relative terms, developing countries suffer much greater capital and tax revenue losses from their rich citizens illicitly moving wealth to financial havens. And they also suffer much greater such losses from multinationals shifting profits among their subsidiaries and thereby accumulating huge fortunes in their tax haven subsidiaries, which buy cheaply from one sister subsidiary and sell expensively to another. The goods go directly from A to C, but profits accrue in B – with the result that the multinational pays no taxes in any of the three countries.
For a state to serve as a tax haven, it must have tax loopholes and must practice strict confidentiality. Many idyllic small states meet these conditions, but mainstream Western states do it too: the US, Switzerland, Luxembourg, Ireland, the UK, the Netherlands, Germany and Singapore. They do it to attract capital, and under pressure from large multinationals. And they at least get to tax the shareholders’ investment income which is boosted by the tax shenanigans of multinationals. The real losers are the poorer states.
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A Washington think tank, Global Financial Integrity, has spent many years analyzing and quantifying illicit financial flows. GFI estimates that these cost developing countries over $1 trillion annually – about eight times as much as they receive in official development assistance. The consequences are fatal. Christian Aid estimates that, if this money were properly taxed, governments of developing countries would have $160 billion more in annual tax revenue. Keeping current expenditure patterns fixed, this would lead to substantial gains in human rights fulfillment for their populations, with increased health spending averting some 350,000 deaths each year of children under 5. In addition, far more capital would be available to fuel economic development.
The international system of tax havens, front companies, false trusts, anonymous accounts and corrupt banks, lawyers and lobbyists – harboring some $21-31 trillion in illicit wealth – is a massive impediment to the eradication of world poverty, to which all states have repeatedly committed themselves, most recently last September when they adopted the Sustainable Development Goals in the UN General Assembly. To reach these Goals, it would be helpful to double aid – but far more helpful still to halve illicit outflows from developing countries and to collect due taxes on the retained wealth and profits.
Another reason to prioritize such reforms is that they would greatly reduce crime: the misappropriation of funds by politicians, civil servants and business executives, the illicit trafficking of people, drugs and weapons, and international terrorism.
A third reason, finally, is the strong inequality-aggravating impact of the underground financial system. The richest 1% of humanity already owns more than half of private wealth – while the poorer half owns 0.6% or as much as the 62 richest billionaires. Inequality is bound to continue rising rapidly as the rich can increase their wealth unhandicapped by law, morality, publicity or taxes. It is not surprising that while offshore assets are rising, they also become ever more concentrated among a declining number of owners. This means that the tax revenues dodged worldwide now accrue almost entirely to the very wealthiest. The resulting huge economic and social inequalities threaten not only development in the poorer states but also democracy and social mobility in the developed West.
The Panama Leaks have opened a genuine opportunity for reform. We must recall that states agreed in 2015 that one of the Sustainable Development Goals is to reduce illicit financial flows by 2030. Yet, if we entrust implementation to the elites, this opportunity will be lost. We must understand the most promising reform proposals – many of which are discussed in the recent OUP book Global Tax Fairness – and must mobilize in their support. While the issues are tedious and complex, we have good intellectual leadership by people in universities, think tanks, NGOs and international agencies who have for years discussed the problem and possible reforms, including recently in the UN Human Rights Council.