Is the Idea of Counting Dollars of Illicit Financial Flows Undermining Action Where It Counts?

The Sustainable Development Goals (SDGs) include a target to “significantly reduce illicit financial flows (IFFs).” While there is no global consensus about what this means, working definitions point to funds that are “illegally earned, transferred, and/or utilized.” The term is thus generally seen as an umbrella for a wide variety of “dirty money” including funds associated with drug, arms, and human trafficking; wildlife and natural resource crime; state capture and illicit enrichment; the financing of terrorism; and the evasion of taxes and tariffs.

Counting the uncountable?

IFFs is a useful composite category insofar as it draws attention to the role of international financial channels in enabling, profiting, and providing a haven for the proceeds of various forms of crime and corruption. However, it is often used in precisely the opposite way: to downplay down these issues. Raymond Baker of Global Financial Integrity, in his 2005 book Capitalism’s Achilles’ Heel, famously argued that grand corruption is a relatively minor contributor to illicit financial flows, responsible for just for a few percent of the total, with proceeds of crime responsible around a quarter, and “commercial tax evasion” (from his studies of trade misinvoicing) contributing the largest portion. This statement has been frequently repeated. However, it is increasingly recognised that the numbers underlying it (based on gaps and mismatches in trade and balance of payments data) are just not reliable. Transactions interpreted as trade misinvoicing and therefore tax-motivated can also reflect the payment of bribes and kickbacks (i.e., corruption) as well as simple noise in the data.

The apparent availability of sets of regular, IFF figures (such as those published by Global Financial Integrity) seems to have been an important influencing factor in creating an expectation that staunching the flow of IFFs could contribute a massive boost to finance for development, and also that generating regular sets of global dollar measures is feasible. Thus the experts who set the SDG indicators optimistically established the indicator to be measured as “the total value of inward and outward illicit financial flows (in current United States dollars).”

The task of coming up with a methodology has been passed to the UN Office of Drugs and Crime (UNODC), together with the UN Conference on Trade and Development (UNCTAD). Last week the organisations brought together an expert group in Vienna to discuss initial proposals towards a global indicator framework.

Should legally compliant taxpayer behaviour be included in definitions of the “illicit”?

A key debate which remained unresolved in Vienna was whether the IFF concept should also cover controversies over corporate tax planning, even where taxpayers are acting within existing tax rules. While tax fraud and tax evasion would certainly be included within the catalogue of lawbreaking transactions, organisations associated with the Tax Justice Network have called for the IFFs definition to include operations by multinational corporations which are within the letter, but not the “spirit” of the law, or which are deemed “socially unacceptable.”

The idea of a separate letter and spirit of the law is problematic. It also seems like a stretch beyond what the SDG drafters intended. Target 16.4; which includes IFFs, brackets it with arms trafficking, the theft of public assets, and organised crime, suggesting that the drafters had in mind the idea of “dirty money” rather than base erosion and profit shifting.

While there are important questions about how to tax multinational corporations and the digital economy, bracketing legally compliant taxpayer behaviour into a single category with criminal and corrupt money flows seems like a singularly bad idea: a recipe not just for bureaucratic confusion and an arms race of big numbers and meaningless comparisons, but also for real world consequences of undermining progress towards clear and effective tax systems governed by the rule of law.  

Misaligned expectations, misaligned measures

Alex Cobham, of the Tax Justice Network, and Petr Jansky developed and presented an initial proposal for estimating tax-related illicit financial flows, developed on behalf of UNCTAD. The proposal is to measure “misalignment” between the locations where corporate profits are declared and the locations where “economic activity of MNEs” takes place by using aggregated country-by-country reporting (CBCR) data submitted by large companies as part of new regulations focused on Base Erosion and Profit Shifting. Economic activity is proposed as the simple average of employee headcount and of final sales within each jurisdiction (this is something similar to Cobham and Jansky’s estimate of misalignment of US company profits, or Oxfam France’s “Opening the Vaults” analysis of country-by-country data published by EU banks).

The advantage of this number is that (like the original trade misinvoicing headline figures) it is easy to calculate from data which will be readily available. (The OECD plans to collect and publish aggregated data from country-by-country reports.) It is likely to produce a large number (which has come to be expected).

The disadvantage: it bears no relationship to tax evasion or avoidance. It compares profits with "real economic activity" using a metric that no tax system in the world currently uses. This is not tax avoidance, but avoidance of a unitary tax which does not exist. Pascal Saint-Amans, director of the OECD’s Centre for Tax Policy and Administration describes CBCR data as the means for tax administrations to smell a rat, ”such as where, for example, you have all your profits in a zero-tax jurisdiction where you have no sales, no employees and no assets.” The proposed metric suggests that rats should be sniffed out wherever global corporations have operations that do not result in homogenous profit margins and labour productivity across diverse locations and business units.

If this ratio were adopted as a UN metric of “illicit financial flows,” it would likely lead to revenue authorities being put under political pressure to adjust taxpayer’s incomes accordingly—despite the fact that CBCR data was not intended to be used as a basis for such “formulary apportionment.” Furthermore, it would encourage a narrow focus on a single tax (and in many low-income countries, very small) set of taxpayers, rather than consideration of other taxes, tariffs, and fees which are often subject to cross-border tax evasion and fraud.

IFF indicators: Where to go from here?

The development of the IFF indicators is not a done-deal, but will be the start of a process that includes expert consultations,  pilot studies, and testing which is envisaged to result in guidelines for national, regional, and global estimates. The methodological work on the indicator is expected to be completed by mid-2019.

Any definition or indicator on tax-related aspects of illicit financial flows should be recognisable to those working in tax compliance (both on the side of tax inspection and taxpayers). The discussions in Vienna (and proceeding them, in Geneva) were notable for the relative absence of engagement by tax practitioners. This was perhaps not on purpose, but rather a reflection that experts from revenue authorities and private practice—and those involved in research, teaching, and technical assistance on tax policy and administration—don’t view their work in terms of “illicit financial flows.” This means that those most likely to question the meaningfulness of a concept that brackets legally earned profits with the proceeds of crime are simply not there to make the case. Those from the private sector are perhaps least likely to engage in a process where it seems they have been cast as the villains from the outset.

The question of whether the desired dollar indicator is feasible and meaningful should not be taken as given. International laundering of the proceeds of crime and corruption is a very real phenomenon. But the ability to measure and track it year-on-year through application of a simple formula to readily available statistics is not. Actors engaged in illegal activity either do not want to be discovered, or are able to operate with such impunity that they do not fear discovery. The prospect of developing a standard methodology and asking national statistics agencies to produce reliable, regular, and standardised figures on the total value of such flows may simply be an overoptimistic quest.

Action on illicit financial flows does not depend on a global “big number.” Indeed, some of the other problems under SDG goal 16. 4—such of return of stolen assets and combatting organised crime—do not have an indicator. There is no SDG indicator on grand corruption. If the chimera of a single number was abandoned, there are other things that could be measured and better understood:

• increasing seizure of proceeds related to corruption;
• increase in the capacity of institutions that tackle wildlife poaching and natural resource crime;
• increasing access to exchange of information agreements (including on country-by-country reporting and automatic exchange of banking information);
• investigation of grand corruption cases;
• number of countries that have eliminated the possibility of banking secrecy; and
• effectiveness of reliable access to beneficial ownership information and of mutual legal assistance.

There is perhaps a fear that multinational tax avoidance will fall off the international development agenda altogether if it is not included in the SDGs under target 16.4. But this seems unlikely. There is already a commitment under Action 11 of the G20/OECD led BEPS programme to measure indicators of Base Erosion and Profit Shifting. And there is a better place for considering the tax affairs of multinational corporations in relation to the SDGs, rather than as an odd-one-out alongside arms trafficking, stolen assets and organised crime. That is under target 17.1: strengthening domestic resource mobilization.

Developing countries should consider international taxation challenges as part of their overall approach to setting tax policy and administration priorities. Rich countries should consider how their tax rules and treaties and the conduct of multinational corporations may either support or undermine tax collection in developing countries.

Strengthening the consistency of international tax rules and the administration of tax law so that it is neither weakly enforced, nor capricious and predatory, would be positive for citizens, businesses, and public budgets, and is good for both inward investors and host countries. Bundling questions about the evolution of international tax rules under a weakly specified but easily sensationalised category of “illicit financial flows” undermines trust, understanding, and the ability to have constructive conversations about how to do this.