Will the new fiscal crises improve international tax cooperation?

Anis Chowdhury and Jomo Kwame Sundaram

SYDNEY & KUALA LUMPUR: COVID-19 recessions have hit most countries, requiring massive fiscal responses. While most developing countries struggled with mounting debt even before the pandemic, many developed countries also face unprecedented macroeconomic pressures despite earlier spending cuts due to ‘fiscal consolidation’ policies.

Tax, not aid?

Before the third United Nations’ Financing for Development conference (FfD3) in Addis Ababa in mid-2015, Organization for Economic Cooperation and Development (OECD) head Angel Gurria acknowledged, “Much of [the tax not collected] is lost abroad in illicit flows. Developing countries also lose tax revenue from aggressive tax planning by multinational corporations. This cannot go on.”

Earlier, then OECD Development Assistance Committee chair, Erik Solheim foresaw an end to official development assistance (ODA): “Nothing would please me more than seeing the end of ODA, and for development to be financed through taxes, normal trade relations, long term investments and sustainable businesses.”

Solheim also observed: “Developing nations need to be in control of their own revenues and economic resources through sound taxation … The fight against corruption and tax havens is crucial in this context…The amount of money leaving developing countries in the form of illicit financial flows each year is many times greater than the amount of aid coming in”.

However, before and at the conference, developed economies ganged up to block developing country efforts to enhance international cooperation to stem such illicit outflows, especially tax evasion.

Losing resources

The UN-initiated Financial Accountability, Transparency & Integrity (FACTI) interim report has made staggering estimates of lost resources that could contribute to development:

• 10% of world output held in offshore financial assets

• criminal money laundering worth 2.7% of global output

• US$7 trillion of private wealth hidden in mainly secret, tax havens

• US$500~600 billion yearly in lost global corporate tax revenue due to ‘profit-shifting’ by transnational corporations (TNCs)

• US$20~40 billion yearly in bribes in developing and transition economies

Illicit financial outflows

According to Global Financial Integrity (GFI), developing countries have lost US$13.4 trillion in unrecorded capital flight since 1980, via trade mis-invoicing and tax evasion, primarily by TNCs and ‘high worth’ individuals, with US$1.1 trillion lost in 2013 alone.

TNCs also steal money from developing countries through ‘same-invoice faking’, i.e., by shifting profits among subsidiaries by false trade invoicing. The GFI figure of illicit funds transfers does not include same-invoice faking, but estimates losses of US$700bn yearly from goods trade alone.

If trade in services is included, net resource outflows total about US$3 trillion yearly, 24 times more than OECD countries’ aid in 2014. In other words, developing countries lost $24 for every $1 of aid received in 2014, depriving them of much needed finance and government revenue for development.

Estimates of trade mis-invoicing in Africa during 2000-2016 averaged US$83 billion annually, totalling US$1.4 trillion, i.e., about 5.3% of Africa’s output value, worth about 11.4% of its trade in that period.

Such illicit outflows are greatest for Asia. Outflows grew by an average of over 9% yearly during 2004-2014, reaching around US$330 [272~388] billion in 2014. The equivalent of 7.6% of tax revenue in the Asia-Pacific region may have been lost to fraudulent trade declarations in 2016 alone.

OECD not inclusive, legitimate

Tax avoidance by TNCs frequently involves tax base erosion and profit shifting (BEPS), enabled by loopholes in tax governance and the law.

In 2013, G20 leaders endorsed the OECD BEPS action plan, requesting it to recommend international standards and measures to tackle corporate income tax (CIT) avoidance. CIT evasion cost US$100~240 billion annually, i.e., 4~10% of global CIT revenue. In response, the OECD initiated the Inclusive Framework on BEPS and the Global Forum on Transparency and Exchange of Information for Tax Purposes.

Developing countries are invited to participate on condition they commit to implement and enforce standards and norms they did not design or decide on, having been excluded from negotiations. Thus, the claim of developing country ‘inclusion’ in the OECD BEPS framework is misleading, to say the least.

Besides illegitimacy and other problems of exclusion, the proposals may also be inappropriate for developing countries. As the FACTI report observes, “Lack of inclusiveness in setting international norms results in implementation gaps and weakens the global fight against illegal and harmful tax practices”.

Digitalisation challenge

Rapid digitalisation presents new challenges, as TNC assets and profits can be easily moved among tax jurisdictions. Ensuring accurate company reporting on actual revenue and profits from each location is necessary for fairer taxation, but the status quo enables evasion instead.

Digitalisation threatens revenue collection as taxation practices try to catch up with innovations in tax evasion. Recent more ‘technology-driven’ businesses – increasingly involving ‘hard to value’ intangible assets such as patents and software – also require improving international corporate taxation.

Traditional assumptions about links between income, profits and physical presence now seem irrelevant, requiring new approaches, principles and norms. For example, countries with many users or consumers of digital services currently get little or no tax revenue from companies denying any physical presence.

But new international corporate taxation in this age of digitalisation should benefit all, both developing and developed countries. With marginal costs close to zero, all revenue can be taxed without adversely affecting digital services supply.

Current tax systems cannot prevent egregious tax avoidance by digital TNCs. For some time, the OECD has been discussing tax avoidance by digital TNCs within the BEPS framework without reaching consensus, mainly due to US opposition.

“With no consensus on taxation of the digital economy, some countries have resorted to unilateral measures”, noted the UN Committee of Experts on International Cooperation in Tax Matters. But such actions have provoked retaliation, e.g., the US threatened new tariffs on French exports following France’s attempt to tax tech giants.

Systemic challenges, cooperative solutions

Poor financial accountability, transparency and integrity – enabling illicit financial flows – is a global problem. As the FACTI report emphasised, the problem needs global solutions, while taking country circumstances into account.

It noted, “all aspects of this problem require action and ownership in developed and developing countries; in source, transit, and destination countries; in public and private sectors; and in small and large countries alike… there are no silver bullets or single measures”.

Governments around the world face severe fiscal pressures responding to COVID-19 economic crises with adequate relief and recovery measures as revenue collection shrinks. As other donor countries emulate the recent UK foreign aid budget cuts, aid-reliant developing countries will face more financing challenges.

As the OECD noted, domestic and external financing levels and trends already fell short of SDG spending needs well before the COVID-19 crises. External private financial inflows to developing economies could drop by US$700 billion in 2020 compared to 2019, 60% worse than the 2008 global financial crisis impact.

Hence, tackling resource haemorrhage from developing countries has become all the more urgent as even developed countries scramble for more fiscal means. This could finally catalyse the long-needed cooperation on international tax matters led by the UN, still the most inclusive and legitimate platform for multilateral cooperation.

Related IPS commentaries

“OECD Tax Reform Proposal Could Be Better”, 15 Oct. 2019. http://www.ipsnews.net/2019/10/oecd-tax-reform-proposal-better/

“Ensuring Fairer International Corporate Taxation”, 3 Sep. 2019. http://www.ipsnews.net/2019/09/ensuring-fairer-international-corporate-taxation/

“South Must Also Set International Tax Rules”, 20 Aug. 2019. http://www.ipsnews.net/2019/08/south-must-also-set-international-tax-rules/

World Bank urges governments to guarantee private profits

Jomo Kwame Sundaram and Anis Chowdhury

KUALA LUMPUR and SYDNEY: The World Bank has been leading other multilateral development banks (MDBs) and international financial institutions to press developing country governments to ‘de-risk’ infrastructure and other private, especially foreign investments.

They promote public-private partnerships (PPPs) supposedly to mobilize more private finance to achieve the Sustainable Development Goals. PPP advocacy has been stepped up after developing countries’ pleas for better international tax cooperation were blocked at the third United Nations’ Financing for Development conference (FfD3) in Addis Ababa in mid-2015.

Official support for infrastructure PPPs seems stronger than ever. The Bank’s Global Infrastructure Facility (GIF) was set up to coordinate MDBs, private investors and governments promoting PPPs. Meanwhile, the G20 has been trying to modify the mandates of national and international development banks to enable them to initiate infrastructure PPPs with the private sector.

De-risking?

The World Bank’s latest Guidance on PPP Contractual Provisions measures progress in terms of “successfully procured PPP transactions”. The Bank explicitly recommends ‘de-risking’ PPPs, effectively involving ‘socializing’ risks and privatizing profits.

But the term ‘de-risking’ is misleading as some risk is inherent in all project investments. After all, projects may encounter problems due to planning mistakes, poor implementation or unexpected developments. Hence, Bank advice does not really seek to reduce, let alone eliminate risk, but simply to make governments bear and absorb it.

Thus, ‘de-risking’ really means shifting risk from private investors to governments for more contingencies, including design, planning or implementation failures by private partners. This ignores the Bank’s Growth Commission’s concern that “In too many cases, the division of labor has put profits in private hands, and risks in the public lap”.

Off the books, out of sight

Both World Bank and International Monetary Fund (IMF) research has found many governments using PPPs and other similar arrangements to keep such projects ‘off the books’ of official central government accounts, effectively reducing transparency and accountability, while compromising governance.

Such project financing typically involves government-guaranteed – rather than direct government – liabilities. Not booked as government development or capital expenditure, it is also not counted as part of sovereign or government debt, e.g., for parliamentary reporting and accountability.

Instead, project costs are supposed to be paid for, over time, by direct user fees or government operational or current expenditure. Hence, most governments do not extend their normal accountability procedures to cover such expenditure and related debt.

The Fund has even warned of likely abuse of such seemingly ‘easy’ or ‘free’ money, emphasising the dangers of taking more government debt and risk ‘off the books’. This is very significant as the IMF rarely criticises Bank recommendations and advice, even indirectly.

Shifting responsibility

PPP financing is typically booked as government-guaranteed liabilities, rather than as sovereign debt per se. Being ‘off the books’, governments face fewer constraints to taking on ever more debt and risk. With such commitments, they also become much more vulnerable to ‘unforeseen’ costs.

Such contractual arrangements, typically set by private partners in most PPPs, do little to improve governance and accountability. To be sure, normal government budgetary accounting and audit procedures for PPPs may not meaningfully improve transparency and accountability.

As such financing arrangements are typically long-term, related government risks are correspondingly long-term, lasting decades in many cases. This tempts ‘short-termist’ governments ‘of the day’ to make long-term commitments they are unlikely to be held personally accountable for in the near to medium-term.

Moral hazard

World Bank guidance is clear that even a private partner who fails to deliver as contracted must be compensated for work done before a government can terminate a contract. Whether private partners actually deliver as promised does not seem to matter to the Bank which provides no guidance for addressing their failures to meet contractual obligations.

The Bank thus contributes to ‘moral hazard’ in PPPs: the less likely the private partner stands to lose from poor performance, the less incentive it has to meet contractual obligations. Guaranteeing cost recovery, revenue and profit erodes the motive to deliver as promised and to consider project risks.

Enthusiastic PPP promotion – by the Bank, other MDBs and donors urging developing country governments to bear more risk – is not only encouraging ‘moral hazard’, but also creating more opportunities for the corruption and abuse they profess to lament.

Instead, private partners have greater incentives to try gouging rents from government partners, e.g., by renegotiating existing contracts to their advantage. Conversely, governments have to choose between bearing the costs of failed projects, and paying even more to save problematic ones in the hope of cutting losses.

Faced with such choices, governments have little choice but to accede to their private partners’ demands. Bank guidance has thus further undermined governments in their dealings with private partners, who are now better able to demand improved contractual conditions for themselves, at the expense of their government partners.

Ignoring evidence

Many governments can undertake large infrastructure projects themselves, or alternatively, make much better procurement arrangements. IMF research has also found, “In many countries, PPPs have not always performed better than public procurement”.

Ironically, Bank research has shown that “well-run public firms tend to match the performance of private firms in regulated sectors”, concluding, “There is no ‘killer’ rationale for public-private partnerships”.

Even the Bank’s Research Observer has published a summary of “some of the most compelling examples of this kind of emerging critique” of infrastructure PPPs in telecoms, transport, water and sanitation, waste management and electricity.

Yet, the Bank continues to promote PPPs as the preferred mode of infrastructure financing, trying to shift more risk to governments, ostensibly to attract more private investment. Meanwhile, Bank guidance typically fails to warn governments of the risks involved and their implications.

Prejudiced guidance

Bank and other PPP advocates dismiss criticisms as ‘ideological’ despite growing empirical evidence. Such damning findings have had little impact on their PPP advocacy. Instead, the new fad is for more ‘blended finance’ to PPPs, using official concessional finance to subsidise and attract more private investment.

However, as The Economist has found, “blended finance has struggled to grow” as MDBs mobilise less than US$1 of private capital for every public dollar. It concluded, “early hopes may simply have been too starry-eyed. A trillion-dollar market seems well out of reach. Even making it to the hundreds of billions a year may be a stretch”.

Unsurprisingly, despite Bank, donor and other efforts, PPPs have only generated 15~20% of developing countries’ infrastructure investments, according to the Bank’s Independent Evaluation Group, while remaining negligible in the poorest countries.

Related IPS commentaries

“World Bank’s ‘Mobilizing Finance for Development’ Not Financing Development”, 25 Aug. 2020. https://www.ipsnews.net/2020/08/world-banks-mobilizing-finance-development-not-financing-development/

“Coping With World Bank-Led Financialization”, 30 Apr. 2019. http://www.ipsnews.net/2019/04/coping-world-bank-led-financialization/

“World Bank Financialization Strategy Serves Big Finance”, 9 Apr. 2019. http://www.ipsnews.net/2019/04/world-bank-financialization-strategy-serves-big-finance/

“World Bank Financializing Development”, 26 Mar. 2019. http://www.ipsnews.net/2019/03/world-bank-financializing-development/

“Blending Finance Not SDG Financing Silver Bullet”, 30 Apr. 2018. http://www.ipsnews.net/2018/04/blending-finance-not-sdg-financing-silver-bullet/

“PPPs Likely to Undermine Public Health Commitments”, 17 Jan. 2018. http://www.ipsnews.net/2018/01/ppps-likely-undermine-public-health-commitments/

How will Budget 2021 address well-being and recovery?

Catch this Astro Vizhuthugal interview (in English) with Jomo, conducted on 29 October 2020, about 2 weeks before the Budget was unveiled, where he observes we are simultaneously facing an economic crisis, a Covid-19 crisis and a political crisis.

He refers to many countries and states which did not resort to severe lockdown measures but relied on strong early and appropriate action, involving an All of Government approach.

Watch the full interview here: https://drive.google.com/file/d/1ua2BQQMV1D-kN5HzjUfl7psb72yCzKxX/view