Our analysis shows that $850 billion to $1 trillion a year of illicit money passes out of developing countries, through the shadow financial system, and into industrial countries. This is the most damaging economic condition hurting the global poor. G20 leaders need to refocus on changing the culture of opacity embodied in the global shadow financial system in order to curtail the flow of illicit money across borders. Several measures can achieve this end—automatic exchange of tax information, beneficial ownership, harmonizing predicate offenses, and country-by-country reporting.
Much discussion has surrounded the issue of tax havens, both leading up to and following the 2 April 2009 Summit in London. Unfortunately, however, the leaders at the Summit chose to focus on re-regulating the current shadow financial system. Instead, the G20 must create greater economic transparency. This is the only way to eliminate tax havens and secrecy jurisdictions and protect the global economy from future credit crises. The good news is that most jurisdictions now agree to cooperate with the OECD model for exchange of information on financial dealings. The bad news is the OECD model itself is weak.
There are three shortcomings that are particularly troubling. First, the state requesting information must demonstrate that the information is ‘foreseeably relevant’ to a case of crime or tax evasion. The jurisdiction receiving the request can interpret ‘foreseeably relevant’ to mean that you must know the account names and numbers and approximate dates of transactions before providing information. In other words, the requesting party must already have a solid case before seeking corroborating evidence.
Second, no state is obligated to ‘carry out administrative measures at variance with laws and administrative practice’ of that state. If it is against the law to reveal information about a client’s banking transactions, then the jurisdiction receiving a request for information faces a dilemma. The OECD convention has a provision that bank secrecy cannot be used as an excuse in failing to reply to a request for information. Thus, the state and the convention can come into conflict.
Third, no state is obligated to ‘supply information which is not obtainable under laws or in the normal course of administration’ of that state. Many tax havens do not require accounting and reporting by entities legally established therein and therefore have little or no information to provide. Therefore a request for information often produces no information.
While the G20 communiqué progressed the tax haven issue, it did not in my judgment offer a solution to the issue or to the very real problem of tax evasion. At the root of the problem is the global shadow financial system, and this can only be addressed with greater financial transparency.
The global shadow financial system moves cumulatively trillions of dollars of illicit money across borders. It facilitates the shift of corrupt, criminal, and commercially tax evading money. Harming developing countries, it drains hard currency reserves, heightens inflation, reduces tax collection, worsens income gaps, cancels investment, hurts competition, and undermines trade. And it likewise damages industrial economies by limiting tax collection, widening income gaps between rich and poor, and eroding free trade.
Global Financial Integrity (GFI) recently completed an analysis of illicit financial flows out of developing countries, utilizing the World Bank Residual Method and IMF Direction of Trade Statistics. Our analysis shows that $850 billion to $1 trillion or more a year of illicit money passes out of developing countries, through the shadow financial system, and into industrial countries. This is the most damaging economic condition hurting the global poor.
G20 leaders need to refocus on changing the culture of opacity embodied in the global shadow financial system in order to curtail the flow of illicit money across borders. Several measures can achieve this end — automatic exchange of tax information, beneficial ownership, harmonizing predicate offenses, and country-by-country reporting.
Automatic exchange of tax information takes the EU Savings Tax Directive and expands it to cover additional forms of income and additional entities including corporations, trusts, and foundations.
Beneficial ownership would require all financial institutions around the world to know the real owners of entities with which they do business. This is important for pursuing tax evasion and for combating terrorism, trafficking, and other criminal activities.
G20 countries cooperating with the Financial Action Task Force in Paris should synchronize predicate offenses under their respective countries’ anti-money laundering laws and add knowingly handling the proceeds of tax evasion to the list. Presently it remains legal in many countries to accept some forms of criminal money and virtually all forms of tax evading money, unacceptable in our globalized world.
Country-by-country reporting of sales, profits, and taxes paid will reduce tax evasion more than any other step. While generating additional tax revenues, it does not require a huge regulatory regime because it is largely self-enforcing. Most importantly, it holds businesses accountable for their fair share of taxes and contributes toward lessening the tax burden on wage earners around the world.
We cannot solve the tax haven problem without addressing the larger problem within which tax havens thrive. Achieving this goal is a matter of political will. The leaders of the G20 must follow through with the kinds of steps outlined above if we are to prevent future financial crises affecting all nations and peoples.
Raymond Baker
Senior Fellow at the Center for International Policy and a Guest Scholar at the Brookings Institution, both in Washington, D.C., researching and writing on the linkages between corruption, money laundering, and poverty. He is the Director of the Global Financial Integrity Program and the author of "Capitalism’s Achilles Heel: Dirty Money and How to Renew the Free-Market System." He has for many years been an internationally respected authority on corruption, money laundering and foreign policy issues, particularly relating to developing economies. He is a member of the Caux Round Table, an international network of business leaders, who see it as their special responsibility to promote moral capitalism and responsible government and to ensure greater prosperity, sustainability and fairness in a global economy.
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