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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.

“Ensuring Fairer International Corporate Taxation”, 3 Sep. 2019.

“South Must Also Set International Tax Rules”, 20 Aug. 2019.

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