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Maya Forstater is a visiting fellow at the Center for Global Development and a researcher and advisor on business and sustainable development. Her work focuses on the intersection of public policy, business strategy and sustainability including questions around tax and development, financing for low carbon investment and multi-sector partnerships and standard setting.
From 2014-2016 she was Senior Researcher for the UNEP Inquiry into the Design of a Sustainable Financial System. She has also worked with the Transparency and Accountability Initiative (for the Open Government Partnership), the South African Renewables Initiative, the Global Green Growth Initiative, AccountAbility and the World Business Council for Sustainable Development. She started her career at the New Economics Foundation, and was involved in setting up the Ethical Trading Initiative. She has published reports and articles on issues including the scale of international tax avoidance and evasion, corporate responsibility by Chinese businesses in Africa, the design of pay-for-performance climate finance mechanisms and the governance and effectiveness of multistakeholder partnerships.
The UK Labour Party recently set out its ideas on international development in a paper titled “A World for the Many, Not the Few.” There is much to like in the policy paper, including pledges to put in place an effective whole-of-government development approach, to advance DFID’s monitoring of whether aid reaches the most vulnerable and excluded, and to communicate more honestly with UK taxpayers about the successes, challenges, and complexities of development.
But its core innovation is a proposed change in legislation to add reducing inequality to the required criteria for aid spending (alongside reducingpoverty), while at the same time “reducing the importance of GDP growth.”
Jonathan Glennie, Director of the Sustainable Development Research Centre at Ipsos, offers a helpful mental model for the difference between reducing poverty and inequality:
Imagine two cars racing, one substantially ahead of the other. Now imagine the slower car speeding up—that’s poverty reduction. . . . If the car in front goes even faster—that’s widening inequality.
As Branko Milanovic has highlighted, global inequality has grown over two centuries, driven largely by inequality between countries (to use the racing cars analogy, if we imagine country populations are teams of cars, the largest gaps opened up between the teams of cars, with teammates bunched up together, rather than between cars on the same team). Since the 1980s, emerging economies have started to close the gap with richer economies through sustained economic growth, at the same time that inequality within some countries has widened. As levels of poverty have fallen faster than ever before in human history, there are fewer cars travelling at extremely low speeds.
In “A World for The Many, Not the Few,” Labour states that it would adopt a standard metric to assess progress on national inequality. The risk is that this metric will, perhaps inadvertently, characterise hundreds of millions of people who would be considered poor by rich-world standards as getting too rich too quickly. With poverty and global inequality still stark—700 million people remain in extreme poverty (below $1.90 a day) and the majority of the world’s population lives below $10 a day—should the UK really be shifting its focus away from poverty reduction, national development, and broad economic growth towards tackling inequality within poorer countries?
Confusing the richest 10 percent in poor countries for the global elite
The Sustainable Development Goals includes a target on national inequality which, in motor racing terms, divides each country’s population between 10 cars and focuses on accelerating the last four cars to close the gap with the pack ahead. “A World for the Many, Not the Few” argues for “raising the bar on SDG Goal 10” by focusing on the gap between the last four cars and the car at the very front of the team (this is known as “the Palma ratio”: the ratio of income between the richest 10 percent and the poorest 40 percent of the population). The paper says that a Labour government would adopt this as the metric for assessing progress on inequality by its development partners. It would encourage all countries to pledge to halve their Palma ratio by 2030 and achieve a ratio of 1 by 2040 (Sweden, Denmark, and the Netherlands each have a ratio of 1).
The chart below shows the income levels of the top 10 percent and the bottom 40 percent together with the Palma ratios for 12 of the 20 largest recipients of UK bilateral aid.[*]
The data shows that the poorest people are very poor, with average consumption amongst people in the lowest decile in DRC, Ethiopia, Kenya, Malawi, Sierra Leone, and Uganda less than $2 per day, and in the other countries a dollar or two more. But people in the top decile are not recognisably rich. In DRC and Sierra Leone, the richest 10 percent of people consume on average less than $10 a day, a level considered impoverished in rich countries. In Ethiopia, Malawi, Nepal, and Uganda, the mean of the top decile is only a few dollars more (these are purchasing power parity dollars, so it is not that the cost of living is less). In Bangladesh the mean income of the top decile is 20 percent less than the Asian Floor Wage, which its promoters argue is what a worker in a garment factory with a dependent family should be paid to have enough to live on (this tells us something about why living-wage campaigns have been so intractable, but it also makes clear that the threshold of the richest 10 percent in Bangladesh is a long way from the global elite).
The chart below shows income by decile for the same set of countries, with the UK included. In none of the 12 countries is the average income of the top 10 percent higher than the UK’s minimum wage.
It is notoriously difficult to assess income distributions (particularly at the very top of the range), and some of these measures rely on surveys that are several years old. Still, the overall pattern is clear: while there will be a small proportion of very rich people at the top of the distribution, there will also be many more people within the top 10 percent earning less than the mean.
Lant Pritchett points out something similar in relation to the quality of education globally. In most developing countries it is not that “the rich get a good education and the poor get a bad one” but “the rich get a bad one and the poor get none at all.” For example, in standardised educational test scores, 15-year-old students from Thailand, Mexico, Mauritius, and Chile fall below the 20th percentile of students in Denmark. Students from Qatar, Ghana, Saudi Arabia, and El Salvador fall below the 5th percentile when compared to their counterparts in Australia.
“A World for the Many, Not the Few” argues that “what people need and want in the UK, people need and want everywhere: our needs, our rights and our struggles to achieve them are one and the same.” Yet at the same time it suggests a development target which counts improvements in the living standards of people who would be considered amongst the poorest in the UK as eroding progress, suggesting that their advancement should be slowed down. What moral authority can the UK have to tell people whose incomes are barely comfortable, and whose priorities are overwhelmingly for jobs and economic growth, that their ambitions and aspirations should be put on hold in pursuit of “happier and more harmonious societies”?
Beyond crude measures
There are certainly reasons to be concerned with inequality within countries. Angus Deaton argues that we should view inequality not so much as a cause of economic, political, and social processes, but as a consequence. Some of these processes are good (areas of economic growth in poor countries), some are bad (uneven access to opportunities), and some are very bad indeed (extractive political institutions and monopoly rents). He argues for sorting the good from the bad in order to understand inequality and what to do about it. As Nancy Birdsall highlights, a rising number of people with steady jobs, a secondary education, and a stake in rule of law and protection of private property rights is a development good, not a development bad, not only for those people directly, but because growth of a middle class in emerging economies has been intimately linked with poverty falling.
DFID should support efforts to address damaging causes of inequality—rigged markets and politics, rent extraction, lack of political voice and agency—and work to increase the productivity and market power of the poor and the emerging middle of workers, traders, and consumers. But if DFID manages-to-the-metric, it might mean refusing to support any investment that would have a first-round effect of increasing incomes in the top decile, including improving the lives of Malawians earning more than $10 a day or Sierra Leoneans earning over $5. It might also mean prioritising projects supporting the 40 percent poorest in Kenya over the poorest 40 percent in the DRC, because even though they are richer, their country’s Palma ratio is higher.
More broadly, the goal of achieving some mathematically Scandinavian level of equality in poor and middle-income countries, and the general disparagement of economic growth in the paper, suggest a zero-sum view of prosperity, which is not in line with people’s aspirations, or their possibility. As Simon Maxwell notes, the paper focuses on the “narrative of predation” but misses out on a companion “narrative of accumulation,” by which countries and people prosper: trade, technology, migration, and mobilisation of finance. Migration, probably the most powerful lever that developed countries for enabling poorer people to improve their lives, barely gets a look-in. As E. Glen Weyl highlights, much migration exacerbates inequality both in sending and receiving countries, and yet reduces global inequality. It is a difficult political issue, much harder to communicate than the story of venal global elites, and it is a gaping hole in Labour’s articulated vision of a fairer world.
Domestic taxation, public services, and redistribution are important, and the consensus, (including from researchers at the IMF) is that moderate redistribution does not impede growth. But it is easy to fall into an overoptimistic vision of what can be achieved through taxing the rich and domestic redistribution. The truth is the many are too poor, the middle too few, and the elite just too tiny for evening up income levels while “reducing the importance of GDP growth” to be the answer for broad prosperity in poor countries.
[*] Where data is available. I also left out Jordan and Lebanon because a large proportion of aid to those countries is focused on refugees rather than on the general population.
Earlier this year, The Centre for Research on Multinational Corporations (“SOMO”; a Dutch NGO) issued a report about an international mining company they said had avoided paying $232 million USD in taxes in Mongolia.
The mine in question is the Oyu Tolgoi (OT) copper and gold mine and the company is Turquoise Hill, a Canadian company, 51 percent owned by the Australian mining giant Rio Tinto. The Oyu Tolgoi mine is considered a big deal in Mongolia and has been subject to lengthy negotiations on how to split the risks, costs, and profits of the project between the company and the government. While this question is of primary interest to the people of Mongolia, I think that delving into the detail of individual cases like this is also important for clarifying the broader debates and understanding of tax issues.
SOMO say their report “reveals how Rio Tinto has managed to pressure the Mongolian Government into signing deals that are detrimental to its own interests” and in this way “been able to design and preserve a tax dodging scheme that has allowed it to persistently avoid substantial tax payments to Canada and Mongolia.” Oxfam uses it as an example of “how poor countries like Mongolia may be losing millions because of corporate tax practices and legal loopholes.” Turquoise Hill in response say that the report is inaccurate and misleading. They say the investment deal was openly agreed with the Government of Mongolia and that the company’s structure (which involves subsidiaries in the Netherlands and Luxembourg) does not reduce tax in Mongolia, and is in compliance with Canadian tax laws.
Both the NGO’s allegations and the company’s defence rest on the same core documents—in particular, the investment agreements between Turquoise Hill and the Government of Mongolia. It is widely accepted that such contracts should be out in the open. The idea of contract transparency is that it will result in more stable and durable contracts, both because they are less subject to public suspicion and because governments and companies will negotiate better deals. Several governments have made commitments to contract transparency on natural resource concessions, and supporters include the World Bank, the IFC, the IMF, the Publish What You Pay coalition, and the Natural Resource Governance Institute (NRGI). As one report puts it:
States and companies may not be hiding anything of great import, but so long as contract disclosure is scattered and leaked materials suggest hidden horrors, that perception will persist—providing easy fodder for demagogues and politicians to make calls for expropriation and renegotiation in cases where it is not merited.
All of the OT Investment agreements have been published and Turquoise Hill is covered by Canadia’s “ESTMA” revenue transparency regulations, while Rio Tinto produces an extensive “taxes paid” report. However, the Oyu Tolgoi case shows that just having these documents and data in the public domain may not be enough. It also matters what you do with them.
Open Oil (a social enterprise that specializes in public interest financial modeling) points out that debates about these kinds of deals often fall into the trap of the single term dilemma: you can point to any one element and argue that it is too high or too low, but what really matters is the overall division of earnings over time; when will each party start to see a positive return from the project, and what will their revenues look like over the 50+ years of operation? Is that fair? And is the investment viable?
Making sense of Oyu Tolgoi
The Oyu Tolgoi project is a massive, technically and operationally complex project. By the end of 2014 almost $7 billion had already been spent on developing it, and the total investment will be around $12 billion.
The thing that complicates the fiscal side of the deal is that the government is getting a 34 percent “carried interest.” Turquoise Hill and its shareholders are covering 100 percent of the upfront exploration and development costs but will only end up owning a 66 percent share of the project, while the government will not put up any of the up-front investment but will end up with a 34 percent share (through the state-owned enterprise Erdenes).
For this deal to work, it has to be acceptable on both sides, taking into account all of the costs and revenues and how they are distributed over time. The main ones are illustrated below:
Table 1. Costs and revenues: Government of Mongolia and Investors
0 percent of project costs upfront
Loss of amenity and natural resource
100 percent of project costs upfront
(+ risks, including fiscal regime issues)
Import taxes on inputs to the project
34 percent of dividends (-interest and principle on loan)
Corporate Income Tax
66 percent of dividends (post tax profits)
Interest on money loaned to government (payable out of future cashflows)
Management fee to Rio Tinto
+ economic spillovers, employment, technology, etc.
Reputation for developing a successful project >> future investment
Scale of the project
Open Oil has previously developed a model of Oyu Tolgoi’s finances and revenues. As it shows, Oyu Tolgoi delivers early revenues in the form of VAT, royalties, and customs and withholding taxes to the government—long before investors begin to receive dividends. Turquoise Hill say to date the project has paid out $1.7 billion in taxes and royalty payments and that the investor side will not commence to be cash flow positive until around 2026.
Figure 1. Open oil model of Oyu Tolgoi government revenues
(base case scenario, with 20 percent withholding taxes)
Are reduced withholding taxes “shameless abuse”?
SOMO’s belief that tax revenues to date should have been $230 million higher in Mongolia than they were, is based on the argument that the project ought to be paying a 20 percent withholding tax on cross-border interest on loans from the parent company (as is shown in the Open Oil base case) whereas in practice this has been reduced to lower levels.
Withholding taxes are taxes on the gross value of cross border payments such as interest. They are simple for governments to collect (compared to profit taxes), and are an important safeguard against companies shifting profits from high tax to low tax jurisdictions. Even in the absence of profit shifting, withholding tax are relatively attractive for governments because they start to generate public revenue early in the life cycle of an investment, rather than waiting for the project to be in the black.
However, a large tax on interest is like an import tariff on borrowing money; it raises the cost of capital. Therefore countries seeking inward investment often sign double tax treaties, which reduce withholding tax rates.
SOMO argues that the 10 percent WHT rate is abusive because it was secured using a double tax treaty with the Netherlands, which Mongolia has since unilaterally cancelled. However as Turquoise Hill points out, had the loans come from directly from Canada the interest would have been subject to the same 10 percent tax rate. Similarly, if the loans had come from the UK, France or Germany the rate would also have been 10 percent. In fact, when the Investment Agreement was signed Mongolia had 30 double tax treaties and only four of them had a withholding tax rate on interest that was different from 10 percent (one higher and three lower). When the IMF undertook a review of Mongolia’s Tax Treaties it recommended that Mongolia adopt a standard WHT rate of 10 percent for interest.
So the 10 percent rate seems unexceptional. However, SOMO also highlights an additional complication: the tax is only paid on the private investor’s portion of interest payments, and not on the portion that relates to the government’s share. Thus the 10 percent goes down to 6.6 percent in practice. SOMO sees this as a further (retroactive) lowering of withholding taxes. Its reasoning is that withholding taxes are formally a tax on the party that receives the interest payments—and not the party that makes the payments. It argues that therefore that “the logic behind this arrangement seems awed [sic].”
But their interpretation does not reflect the way that withholding taxes work in commercial practice. The cost of the tax has to be priced in and it typically raises the cost for the borrower, rather than lowering the return that a lender is willing to accept. In practical terms, interest rates are usually specified as “net of all taxes” with the borrower required to gross up the payment to cover any withholding tax. That means that if WHT was charged on Erdenes’ share of borrowing, it would be the government paying it to itself (by borrowing additional money from the project). This would bring forward revenues, but the value of the withholding tax would need to be taken off the value of dividends which might be received in later years, with added interest.
While it seems like an exaggeration (or a misunderstanding) by SOMO to call these issues “abuse,” their report does highlight a question about whether the implications of the treatment of WHT for the overall deal were fully understood. This is perhaps even more important going forward than in assessing the taxes paid so far. Using Open Oil’s base case model the difference between a 20 percent or 6.6 percent withholding tax on interest could be worth around $1.3 billion over the life of the mine (undiscounted), while the difference between a 20 percent or a 0 percent dividend withholding tax (as secured by the Netherlands treaty) is worth around $3.7 billion.
Turquoise Hill argue that it was always clear that the equity investor was a Dutch entity, and would therefore use the Dutch tax treaty. We cannot simply assume, as SOMO do that the project would be viable (or that there would not have needed to be concessions in other areas of the deal) if loans were subject to an additional 13.4 percentage points of withholding tax on interest (as well as a 26 percent tax on the interest received in Canada as SOMO also argue).
While it seems unlikely that the negotiators on either side would simply have left the question of withholding tax rates unsettled, what is not clear whether the implications for project’s revenues were clearly understood and communicated across the government and to wider stakeholders. The fact that neither the IMF nor Open Oil’s models of the project seems to correctly reflect the Netherlands tax treaty suggests that the implication of tax treaties were not widely obvious even to careful observers. Turquoise Hill and the Mongolian tax authority have also had large differences of opinion about how much tax is due from the company. In 2014 a bill was issued for $127 million USD for unpaid taxes from 2010 to 2013, which was subsequently cut by more than 75 percent on appeal. Turquoise Hill is currently in dispute with the Mongolian revenue authority over whether their outstanding taxes for 2013 to 2015 are $5 million or $155 million (it has been suggested by industry analysts that this also relates to withholding taxes).
Could contract transparency be better?
Natural resource contracts are increasingly put into the public domain. But as this case highlights, making sense of the numbers and the legal documents is not straightforward and deals remain open to claims of abuse and loopholes, which may not necessarily be well founded.
The World Bank, NRGI, and the Columbia Center on Sustainable Investment have sought to bridge the knowledge gap with the ResourceContracts.org database which annotates contracts to make them easier to find and understand. NRGI provides training and support to civil society organisation and parliamentarians in analysing contracts (including in Mongolia). Open Oil develops open source fiscal models of oil, gas and mining projects.
However, contract terms alone don’t tell the full story, and are easy to misinterpret. Ali Readhead and David Mihalyi argue that it would be beneficial if the Government of Mongolia and Turquoise Hill produced a joint communique on which WHT rates apply for the shareholder loan, the project finance loan, and future dividends.
More generally, perhaps what might be helpful would be to develop open public “term sheets” for oil, gas, and mining contracts which set out the basic variables contained in contracts and the relevant laws and treaties needed to develop a fiscal model. This would provide a crucial link between open contracts and fiscal models, and by using a standard template might be able to make clear whether each party, and the public have adequate information to judge the deal. Companies and governments could support public understanding by providing such information proactively, alongside publishing the detailed contracts.
If transparency about contract terms matters, then so too does the way that this information gets interpreted and shaped into stories. The SOMO report was developed according the organisation’s own quality standards: a draft was sent to Rio Tinto two days before Christmas and the final report published at the end of January, giving little time to engage with the company’s response. A single unnamed “fiscal practitioner” was consulted as peer reviewer. It is not clear whether this person had good knowledge of project finance, but it seems unlikely. Oxfam judged this to be good enough to take the story at face value, without a second opinion, and amplified it to a broader audience.
I don’t think those quality standards are adequate if what we want is serious and credible analysis. Getting better depends on consumers demanding better.
The consumers in this case are the community of people who think that it is worth reading, writing and funding (and quoting, retweeting, remembering, and using…) public analysis about the extractive sector and public revenues (if you got to the bottom this blog post you are part of this club). Accepting lower standards of analysis and review means giving up on trying to tell a real scandal from a sensational headline.
With thanks to Rhodante Ahlers and Vincent Kiezebrink, Ross Lyons, Ali Readhead, David Mihalyi, Dan Neidle, Alistair Watson, and Paddy Carter for thoughts and comments.
The Sustainable Development Goals (SDGs) include a target to “significantly reduce illicit financial and arms flows, strengthen the recovery and return of stolen assets and combat all forms of organised crime” (Target 16.4). However, there is no globally agreed upon definition for “illicit financial flows” (IFFs). My new CGD paper looks at why there is so much disagreement and confusion over this term.
Sandwiched between gun running, stolen assets, and organised crime in the Global Goals, it is clear that the core idea of illicit financial flows is concerned with “dirty money” that crosses international borders—one common formulation is money that is “illegally earned, transferred, and/or utilized.” This includes the proceeds of crime and corruption: illegal trade, embezzlement, bribes and kick-backs, terrorist finance, and misreported transactions that evade tariffs or taxes. In countries with foreign exchange controls, movements of money dodging currency controls would also fall under the definition. The idea of illicit financial flows is important because it highlights that crime and corruption are not just the problem of the country where they happen, but of the countries that allow their financial systems, goods trade or real estate markets to be used as getaway vehicles for ill-gotten loot.
Figure 1. Core concept of illicit financial flows
All of this seems relatively clear (although difficult to measure—such financial flows are obscured and hidden by design). However a case has also been made, for example, by coalitions such as the Global Alliance for Tax Justice and the Global Financial Transparency Coalition that illicit financial flows should be defined more broadly in relation to breaking some line of moral acceptability.
In practice this argument does not aim to draw up a list of morally acceptable and unacceptable things that people could do with their money (which would of course be impossible), but is focused on a particular issue; that “tax avoidance” should be included within the IFFs definition. This would bracket legally compliant taxpayer behaviour into a single category with criminal and corrupt money flows.
I argue that this broad approach is not coherent, and undermines the rule of law.
Grey areas on tax planning and tax evasion: not really so grey
One argument for taking the broad approach, which is often seen as compelling is the idea that there is a large “grey zone” reflecting an absence of clear defining lines between legal tax planning and tax evasion. Transfer pricing and trade misinvoicing are often highlighted as representing this overlapping practice. This is usually illustrated with big estimates, such as that trade misinvoicing drains $800 billion (USD) annually from developing countries, or that it is responsible for $50 billion of illicit flows from Africa.
While there are of course real legal uncertainties and enforcement failures, it is becoming clear that these issues are not well represented by adding up gaps and mismatches in trade data, which often do not reflect misinvoicing at all. Even more fundamentally it is a mischaracterisation to interpret “misinvoicing” as an example of the same kind of thing as legitimate questions over transfer pricing. On the one hand is customs fraud and smuggling, which is a channel for illicit financial flows, and on the other there are ordinary questions over determining acceptable “arms-length” prices for subsidiaries of a multinational corporations to charge between themselves.
For example, a report by Olivier Longchamp and Nathalie Perrot of the Swiss NGO Public Eye provides a good outline of how commodity price manipulation can be used as a means to enable illicit (i.e., illegal) financial flows. They map out several different arrangements between trading companies, “politically exposed persons,” and state-owned enterprises to transfer bribes and kickbacks by misreporting the value of commodity trades (the diagram below is only the simplest of a series).
It is sometimes argued that excluding legal tax planning or resulting “misalignment” from the definition of illicit financial flows means excluding multinational corporations from the scope. However, this is not true, instead it draws the line between corporations acting lawfully and acting in ways that break the law or that abet crime and corruption.
The Swiss Eye report highlights cases such as abuse of the Iraq Oil for Food program involving Glenclore, Vitol making payments to individuals close to the President of Congo-Brazzaville, Glencore (again) over-billing ore from Kazakhstan and paying commissions to a close advisor of the president, and Alcoa’s involvement in trade price manipulation in order to make side payments to a minister in Bahrein. Other cases such as Siemens historic bribe paying and Operation Car Wash in Brazil (involving many companies including Petrobras and Odebrecht) are also well known.
Another recent report The Plunder Route to Panama by the African Investigative Publishing Collective highlights how international financial centres (including London) become the end point for resources plundered through corrupt deals involving politicians and well-connected people. The South African Centre for Investigative Journalism amaBhungane has tirelessly investigated the use of manipulated contracts and misreported payments to deliver kickbacks and embezzle funds from public enterprises in South Africa. In the UK, Lord Peter Hain called for the government to seek a criminal investigation into whether HSBC and Standard Chartered banks facilitated the illicit transfers from South Africa.
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 there is a better place for considering the tax affairs of multinational corporations in the global goals. That is under target 17.1: strengthening domestic resource mobilization. Rich countries should consider how their tax rules and treaties, the development of international tax norms, and the conduct of multinational corporations may support or undermine tax collection in developing countries.
Strengthening the consistency of international tax rules and the administration of tax law so that they are 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 everything under a weakly specified and easily sensationalised category of “illicit financial flows” undermines trust, understanding, and the ability to have constructive conversations about how to do this.
Illicit financial flows (IFFs) connected with corruption, crime, and tax evasion are an issue of increasing concern. However, there is not yet a clear consensus on how to define illicit financial flows, and even less on how to measure them.
This paper looks at estimates of the potential gains from taxing across borders, alongside largely domestic measures such as property tax, personal income tax, VAT, and tobacco taxes. It finds that while action on cross-border taxation could yield additional tax take in the region of one percent of GDP, in many countries measures targeting the domestic tax base might deliver something in the region of nine percent. The main enabler is political commitment.
Domestic measures have greater potential for raising tax yields over time. Rough estimates indicate that there may be $9 of additional tax capacity from domestic policy measures for every $1 from international action. The main enabler is political commitment.
Read the full policy paper “Tax and Development: New Frontiers of Research and Action” here.
Or read the policy brief here.
In New York, on Valentine’s Day, 450 tax professionals will gather for a major conference on tax and development. The Platform for Collaboration on Tax, a joint effort of the IMF, OECD, World Bank, and the UN, will bring together finance ministers and senior tax officials, development agencies, foundations, International NGO leaders, academics, researchers, and tax professionals from the private sector, around the role of tax in advancing progress towards the Sustainable Development Goals.
This gathering—perhaps the largest and most diverse of forum on tax and development—reflects the increasing attention on tax for development, and the critical role that international civil society have played in pushing it up the agenda. It is clear that countries’ own resources are fundamental to development, providing the largest share of financing, even in the poorest countries. There is both potential and need for governments to collect more tax and to do it more effectively, as economies grow. To support this, the Addis Tax Initiative was launched in 2015: 19 donor countries, plus the European Commission pledged to collectively double their technical cooperation for domestic revenue mobilisation by 2020. Partner countries—including Ethiopia, Ghana, Indonesia, Kenya, Liberia, Malawi, Philippines, and Uganda—pledged to step up domestic revenue mobilisation. And all players committed to promoting “Policy Coherence for Development.” Around the same time the G20/OECD Base Erosion and Profit Shifting programme launched into action, and now involves 111 countries, including many emerging and developing economies.
But discussion on tax and development can be pretty incoherent, both within and between different sectors. Debates between those seeking to invest and grow businesses and to improve investment environments, and those seeking to secure public revenues and accountability through domestic resource mobilisation have often been fractious, disconnected or antagonistic. A symptom of this is the tendency for inflated expectations about the scale of revenues at stake in relation to multinational corporations and misunderstandings and contested definitions on the issue of illicit financial flows.
Towards policy coherence
My new CGD paper seeks to get beyond the debates and misunderstandings about the “big numbers” to explore what real policy coherence for development over tax could mean. It highlights underexplored opportunities for improving domestic resource mobilisation if we “do tax differently” thinking of taxpayers not only as sources of incremental revenue but also as players in the economy, and stakeholders for state capability (see Eight Ideas).
Getting a sense of relative proportion about international and domestic tax issues is a critical starting point. It is often suggested by both international actors and domestic politicians that international tax issues are the most important factor holding back domestic resource mobilisation. The paper looks at broad estimates of potential additional tax in the three areas, illustrated below: (A) the domestic tax base, (B) the “overlapping tax base” between countries (such as where taxes on the profits of multinational corporations are determined using transfer pricing and tax treaties) and (C) the “hidden tax base,” where high net worth individuals use opaque offshore structures to evade taxation.
It finds that while estimates of the potential gain from improving international tax rules and administration across B and C could approach 1 percent of GDP for low and lower middle-income countries, potential additional tax from domestic policies across the broad tax base could be around 9 percent of GDP. As Mick Moore and Wilson Prichard at the International Centre for Tax and Development outline, there are significant opportunities to collect more tax as the economies of low-income countries grow, mainly through domestic policy action areas such as reviewing tax expenditures and incentives, improving VAT systems, collecting personal income taxes, property taxes, and enhancing the design of extractive sector fiscal systems. Many potential gains are achievable over time with modest financial expenditure and accessible levels of technical expertise, although care also needs to be taken that taxes do not increase poverty. The main enabler of change is political commitment strong enough to overcome vested interests among taxpayers, politicians, and tax administrators themselves. Ultimately the development benefit depends on taxes being spent well to provide valued public services.
This leaves donor countries, international organisations, foundation funders, and international NGOs with a dilemma: many of the most internationally accessible and salient levers of policy and influence relate to the 1 percent of cross-border rules rather than the other 9 percent of domestic tax policy and spending. Technical advice and capacity building in areas such as property tax and reducing tax exemptions can be “pushing on a string” if there is no political will to tax local elites more, or to give up the direct political tool of discretionary tax exemptions. There is a real danger that an intense public focus on the accessible and morally appealing (and often inflated) prospect of collecting incremental tax revenues through international tax action will distract government and civil society from a clear focus on how tax revenues, overall are collected and spent, and undermine investment. It can already be seen, particularly in the extractive industries, that inflated expectations can lead to vicious circles of policy and administration uncertainty and mistrust between taxpayers and governments, and to fiscal indiscipline and economic underperformance.
Fundamentally, what should prick the bubble of inflated expectations is remembering that for any government to collect a large proportion of its country’s GDP as tax revenue, it requires a large proportion of people in the economy to bear the burden of tax. The ability to use international mechanisms (or the push of technical advice) to compel people to pay more tax than has been secured through a social contract with their government is (thankfully) limited.
This is not just an inconvenient truth about the limits of development cooperation, but a fundamental one about the process of development. National development involves a shift from being a low productivity, low-tax country where voters do not expect fair treatment from revenue authorities or decent services from government, to being a prosperous country where public goods are secured by a government held accountable for tax and spending. It requires sustained economic growth and development of accountable institutions. And it is something that is done by people, not to people.
A path forward on taxation and development
This recognition that “tax is political” tends not to come up so much in the technically focused session of international tax conferences—focused on global tax rules, cooperation mechanisms, and capacity building programmes—but does in the late-night conversations.
Policymakers, tax experts, tax payers, tax professionals, and advocacy organisations need to find new ways to test ideas, share knowledge, collaborate, and learn together. This requires new narrative about tax and development, which is not defined by the promise of unfeasibly large revenues from taxing a narrow tax base multinationals, or solely focused on the incremental adoption of “best practice” tax policy and administration. Keeping the triple goals of revenue mobilisation, sustained economic growth and development of accountable institutions front and centre may provide a route towards common ground.
One useful way to think about the politics of taxation in practice, is in terms of the shift “from deals to rules” as described by Lant Prichett, Kunal Sen, and Eric Werker. They view development as a linked process through which fair and enforced rules co-evolve with increasingly productive economies. The linkage is that most efficient firms tend to do better in investment environments where more of the transfers to and from the business (including taxation) are through official, predictable “rules” based channels, whereas less efficient ones can out-compete them where rents can be informally negotiated through “deals.” Taxation is essentially a rules-based form of extraction. What international businesses say they hate about tax is not so much the prospect of paying it, but facing uncertainty about it.
Prichett, Sen, and Werker argue that we should stop thinking of the private sector as a homogenous group, but look instead at the microclimates for different kinds of firms, based on the relationship between local elites and international market players, and how these can give rise to constituencies for reform. This opens up opportunities to think about how internationally accessible policy and influence levers might support the political economy of efficient, rule-based business in key sectors, leveraging the interest of taxpayers as advocates and supporters of reform.
While there is certainly need for long-term thinking on global tax reform and potential redesign of the tax system, as well as immediate action to close loopholes in the international tax system, and build capacity within revenue authorities, it is worth exploring the potential to develop targeted and practical approaches which view taxpayers not simply as potential sources of additional revenue, but as potential constituencies for reform in a shift from deals to rules.
The paper raises eight ideas for win-win approaches:
An “MLI for Development.” The Multilateral Instrument (MLI) has shown how tax treaties can be changed multilaterally. Could an MLI for Development be developed based on a set of minimum treaty provisions to support the needs of developing countries to balance investment certainty and simple revenue collection?
Peer review mechanism for responsible tax practice. Multinational corporations are increasingly publishing tax principles and policies. Could businesses and others develop a peer review or broader assurance process on their practice and performance as responsible tax payers?
Dispute resolution for development. Dispute resolution and mandatory arbitration are being promoted as part of the BEPS Action Plan as a means of securing tax certainty. What steps should be taken to make dispute resolution mechanisms accessible and useful for low-income countries?
Improving the effectiveness of the UN Tax Committee. The UN Tax Committee plays an important role as a forum for developed and developing countries to address tax issues, in complement to the OECD processes, but it is constrained by lack of resources and some of its own procedures. How should the UN Tax Committee evolve to make it a more effective forum to serve the needs of developing countries?
Business tax roadmaps. The Global Platform is promoting Medium Term Revenue Strategies as a coordination mechanism for policy, administration and legal development. Beyond being a bureaucratic mechanism linked to international funding, could governments engage with business stakeholders and develop business tax roadmaps to certainty to enable long-term investments?
Technology solutions for identity assurance. The ability to identify the ultimate beneficial owners of accounts and corporations is crucial to detecting, tracking, and preventing illicit financial flows, and for tax administration, but, it does not necessarily follow that all ownership details should be required to be publicly searchable. Could a blockchain or other technology solution be used to provide a solution for compliant confidentiality, and secure identity and beneficial ownership certification?
Investment grade tax policy for project finance. Tax uncertainty is a key barrier in developing multi-country investments such as power and infrastructure projects with bespoke deals often negotiated to overcome underlying complexity in the tax system. Could a simplified system for taxation of project finance be developed through a multisector collaboration involving governments, private sector, and development finance institutions?
A “race to the top” of international financial centres. International Financial Centres are decried as ‘tax havens’, but at the same time they provide useful access to internationally trusted legal systems and modern, simple administration. Can the characteristics of a responsibly competitive international financial centre be identified, measured and developed into an index of responsible competitiveness of financial centres demonstrating integrity and ability to mediate and support investment?
I will continue to point out misunderstandings and inflated expectations around the tax “big numbers,” if they continue to be produced. The aim is not to turn people away from focusing on the international aspects of tax and development but to see if we can find a common ground to explore and test ideas which could gain the support of policymakers, taxpayers, civil society, international organisations, and tax professionals.
At the Buzwagi and Bulyanhulu gold mines in Tanzania, and at the Port of Dar Es Salaam, around a thousand containers of copper-gold concentrate (a processed product between rock and refined metal) are stockpiling. They belong to Acacia Mining PLC, who operate the two mines, and are not moving because of a ban on concentrate exports that has been in place since the beginning of March.
In May, President Magufuli appointed two special committees to investigate the contents of 277 of the containers stuck at the port. The first committee reported that the concentrate contained around twice as much copper and silver, and eight times as much gold than was declared by the company (the main value of the concentrate comes from gold). They also detected a range of rare earths. According to their calculations, each container contains 28 kg of gold and is worth $1.36 million while information published by Acacia suggests that each container contains 3.3 kg of gold, 2.8 tonnes of copper, and 2.6 kg of silver and is each worth around $0.15 million. If the committees’ findings are accurate, the extent of the undervaluation would be enormous, amounting to almost $4 billion annually (one tenth of Tanzania’s GDP). The second committee scaled these figures up to cover 61,320 containers exported between 1998 and 2017, suggesting the true value of concentrate exports was $83 billion and that the government had lost $31 billion of revenue trade due to misinvoicing and transfer price manipulation. Acacia maintain that they have always declared all materials produced and paid all royalties and taxes that are due.
Credit: Maya Forstater (author), based on data from Mruma Committee Report and Acacia/SGS information
We should summon them and demand that they pay us back our money. If they accept that they stole from us and seek forgiveness in front of God and the angels and all Tanzanians and enter into negotiations, we are ready to do business.
The business in question is the demand that Acacia build a local smelting facility (the government’s stated aim for the ban on concentrate exports). In 2011, The Tanzania Minerals Audit Agency examined the viability of a smelter and concluded that it would not be profitable given the volumes and quality of concentrate involved. If the concentrate produced by the mines turned out to contain eight times more gold than previously thought, these calculations might look different.
However, the committee’s belief that they have uncovered a case of massive misinvoicing (i.e., misrepresentation of the value or quantity of exports) does not seem plausible for five reasons:
1. The findings suggest a massive scale of hidden metals production.
The committee’s reports say that the 277 containers (which represent around one month’s production) contain around 7.8 tons of gold. This is roughly equivalent to the total amount of gold Acacia reports that these two mines produce in a year. Acacia note that the committee’s findings on the amount of Iridium in the concentrate (16.9 tonnes annually), would be nearly three times global consumption of the metal. The findings for Ytterbium (9.8 tonnes annually), would be on par with largest producer in the world.
2. These findings are geologically implausible.
Acacia notes that the results imply that they produce (from Acacia’s three mines in Tanzania) more than AngloGold Ashanti produce from 19 mines, Goldcorp from 11 mines, and Kinross from 9 mines, and that this is implausible given the size of the mines. They also argue that economic Iridium concentrations are only found as by-products in certain types of mines, not in gold deposits of the type found at Bulyanhulu and Buzwagi, and similarly, that significant levels of rare earth elements such as Ytterbium are not found in this kind of deposit.
3. The committee’s analyses suggest an extraordinary conspiracy has undermined Tanzania’s efforts at monitoring minerals exports, as well as international financial regulations.
The Tanzania Mineral Audit Agency (TMAA) undertakes careful work to monitor minerals exports. Normally four samples are taken from every shipping container—one for Acacia (which is verified by SGS), one for the TMAA, one for the smelting company, and an umpire sample in case of disputes. Furthermore, Acacia is a FTSE250 company; it must comply with international regulatory agencies in the UK, Canada, and the United States, which require the company’s financial statements and figures to be audited in accordance with international standards. For Acacia to under-report its gold production and revenues would mean defrauding shareholders through an enormous global conspiracy.
4. The committee’s approach to pricing the concentrate does not reflect how the metals industry works.
The committees calculated a value for every element including trace elements such as tantalum, beryllium, and ytterbium, and bulk ones such as sulphur. However, smelters do not pay out for every element in the material, but only the ones they contract for, since the rest end up in the waste pile or eventually as “anode slime” by-products at the end of the copper refining process. Acacia say they are only paid for copper, silver, and gold (and MRI Group which buys the concentrate from them confirm this).
5. There is no sign of an additional $4 billion a year of unexplained sales in Acacia’s accounts.
Acacia’s shareholders, who have some skin-in-the-game to know what is going on, are not reacting like they have just found out that the company’s management have been defrauding them, nor that the company owns assets which are worth several times more than they thought.
While the committees’ findings are hard to believe, this doesn’t necessarily mean government isn’t justified in its concern that Acacia has not been paying enough tax. Between 2010 and 2015, Acacia paid $444 million in dividends to shareholders, despite not yet paying any income tax in Tanzania. OpenOil explains that generous fiscal terms are the primary cause, specifically, an additional capital allowance meant Acacia could deduct 100 percent of its $4 billion investment, plus a 15 percent margin, before paying any income tax.
$252 million was a “special” dividend following an initial public offering (IPO)—in other words, these funds went from new shareholders to Barrick Gold, not from the Tanzanian subsidiaries to all shareholders. However, the question of how profits to pay the rest of the dividend were available in London has never fully been answered. One possibility is that Acacia is engaging in “base erosion and profit shifting” via its Group Finance Company in Barbados. Acacia may be raising equity, and, through the Group Finance Company, providing it as intercompany loans to its Tanzanian subsidiaries. Because interest payment on the debt can be deducted from taxable income, the more debt the mines have the less taxable income they generate. Plus, interest payments are a way of shifting profits earned in Tanzania, to the Group Finance Company in Barbados. This practice of “earnings stripping,” could explain how Acacia financed the dividends. But, without access to disaggregated data for finance charges, it is not possible to know whether this theory is correct.
In Tanzania, there is significant risk attached to challenging the committees’ findings. The Minister of Mines and the chief of the TMAA were both fired following the first committee’s report, and a weekly magazine was ordered to shut down for two years after publishing an article questioning the role of previous presidents in negotiating the original mining agreements. The “Publish What You Pay” coalition of NGOs working on extractive industry transparency report has issued a general statement, but has not offered any analysis, while the Tanzania Extractive Industry Transparency Initiative has made no public statement.
It is not clear that compelling Acacia to build a smelter would be a win for Tanzania. Thomas Scurfield at NRGI warns that it would distract government attention and power supplies from other areas of the economy and might result in lower government revenues, not higher, if the marginal increase in export value it generates is offset by higher costs. Without balanced coverage of the issues related to revenues, and the economic prospects for smelting, Tanzania may end up worse off. To date, media coverage of the situation has been unbalanced, and potentially misleading.
Securing mining revenues is a major challenge for Tanzania, as with other resource-rich developing countries. Often governments know something is wrong, but lack the information, resources, and expertise to pinpoint the precise cause. However, it is vital that public debate is informed and critical, and that simplistic narratives portraying multinational mining companies as undertaking massive ‘illicit financial flows’ through widespread mispricing of ores and metals are not accepted without evidence. Governments should also avoid this trap at risk of raising public expectations of mining revenues to unsustainable levels.
">Acacia and the government are now sitting down to talks with the hope of reaching a “win-win” solution. Finding a way to unwind inflated expectations, build trust and effective, realistic public scrutiny will be critical to finding a solution which is not just win-win for the president and Acacia but also for the people of Tanzania.
">Alexandra Readhead is an independent advisor on international tax and extractive industries.
At the Financing for Development conference in Addis Ababa this week, the issue of international cooperation to address ‘tax dodging’ and illicit flows will be higher up the agenda than ever before. Credit for this is due in no small part to the various non-governmental organizations that have built up public consciousness and pressure through sustained campaigns focused on the tax affairs of multinational companies.
In the attached paper, we find that the potential for governments to raise additional revenues by taxing multinational companies is limited by the actual levels of profit generated by foreign direct investment in each country; changes to effective tax rates may also have impacts on investment prospects. Estimates of corporate tax dodging are often presented, mistaken, or repurposed in a way that exaggerates potential impacts - for example, large aggregate tax loss estimates are compared with aid revenues or healthcare funding gaps, implying that taxes raised in China, Brazil and South Africa might be available for public spending in Cambodia, Haiti and Malawi. Multi-year tax estimates are compared with annual costs of nurses or teachers. In some cases larger estimates (‘trillions’) which relate to estimates of corruption, informal sector activities or offshore assets held by domestic citizens are mistakenly repurposed to represent complex tax planning practices of multinationals. Much-quoted figures such as ‘‘developing countries lose three times more to tax havens than they get from aid each year” and “‘60% of global trade takes place within multinationals” or “Zambia could have doubled its GDP” are not likely to hold up.
Taxes are a critical source of revenues for development and we appreciate these preliminary findings could be controversial. We welcome comments on our blog as we take the next steps towards a better understanding of tax avoidance and domestic resource mobilization.
One thing that's clear is that data are scarce, which in turn makes it hard to find robust and broadly-supported analyses. Instead, a popular narrative has emerged that the amounts involved are very significant in relation to the revenue base of the poorest countries, and that tackling tax dodging would generate enough funding to achieve ambitious development goals. Recent estimates (such as by the IMF and UNCTAD) put the scale of potential revenues in the region of $100- $200 billion; mostly in the large, emerging economies--it is hard to square these figures with the perception that additional taxes collected will be in problem-solving amounts for the economies of the poorest countries.
We live in a world of imperfect information and we acknowledge those who have made the effort to get the conversation going. We also understand that public statements are designed to get the attention of policymakers who are often occupied with other things. It is our hope that the draft paper builds on the work already done to move towards better numbers. We grateful to the many tax experts from across research, advocacy and tax professions who have contributed so far to discussions and debates around this paper and to helped to clarify assumptions and misunderstandings, including our own. In particular, we would like to acknowledge our advisory group--Alan Carter (Her Majesty's Revenue and Customs), David McNair (ONE), Judith Freedman and Mike Devereux (Oxford Centre for Business Taxation), Marinke Van Riet (Publish What You Pay), Mike Truman (retired editor of Taxation magazine), Paddy Carter (Overseas Development Institute), Robert Palmer (Global Witness), Heather Self (Pinsent Masons), Wilson Prichard (International Centre for Tax and Development), Gawain Kripke (Oxfam America), Jonathan Glennie (Save the Children) and Jeremy Cape (Dentons). The advisory group members participated as individuals rather than as organizational representatives, and the paper is not a collective product. Nevertheless it has been strengthened by their inputs, and their willingness to engage openly to try to find areas of common understanding, and clarify the basis for disagreements.
A key goal of tax-and-spending policies is to alleviate poverty by redistributing income from the haves to the have-nots. The extent that this is possible depends on the balance between the number of higher earners and the number of poor people, and the efficiency of the mechanisms used.
Until a few years ago developing countries did not have the capacity to reduce poverty in this way, as Martin Ravillion at the World Bank calculated; in most countries there were just too few rich people and too many poor people. But over the past decade, economic growth has reduced the number of people living in extreme poverty, and increased the numbers who could afford to pay more tax. Rising inequality strengthens both the moral and practical case for redistribution.
When Chris Hoy and Andy Sumner ran the same calculation last year they found that, in theory (if there were no administration costs, and cash transfers could be perfectly targeted) middle income countries such as China, India, Brazil, and Indonesia could eliminate three quarters of global poverty through tax-and-redistribution. In practice many countries have developed cash transfer programs, such as Brazil’s Bolsa Familia, China’s Dibao, and Indonesia’s Bantuan Langsung Sementara Masyrakat (BLSM), which reached some 700 million people.
But while increasing affluence creates greater potential for redistribution, it quickly runs into limits. When Hoy and Sumner talk about “taxing the rich,” the group of taxpayers they are looking at is mainly comprised of people who are barely affluent themselves. For example, they calculate that to bring the poorest up to $1.90 (2011, PPP) requires a marginal tax of up to 2 percent in Brazil, China, and South Africa, rising to 6 percent in Indonesia and 23 percent in India, for everyone whose income is more than $10 a day (on top of taxes for other areas of public spending).
Furthermore, the apparent affordability revealed by these calculations depends heavily on assuming that payments can be targeted (at no additional cost) precisely to bring individuals up to the poverty line by a few cents a day. In actuality, cash transfers are chunkier sums distributed less precisely. As Berk Özler at the World Bank points out, this is not a trivial matter in working out how many people can be brought out of poverty with each dollar of redistribution (and as Lant Pritchett reminds us, trying to get more people just over any particular line is not the point, because there is no line).
The inconvenient truth is that in practice the combination of tax, spending, and redistribution undertaken by governments often makes significant numbers of poor people worse off. As Nora Lustig’s Commitment to Equity project highlights, the net result of taxes and benefits in Armenia, Bolivia, Brazil, Ethiopia, Ghana, Guatemala, Honduras, Sri Lanka, and Tanzania is that more people are below the $2.50 poverty line than before. In Indonesia, Mexico, Russia, and Tunisia between one-quarter and two-thirds of the poor have less income as a result of the fiscal system.
In other words: there is capacity for redistribution to reduce poverty in many middle-income countries, but it is not painless or unlimited, rather it is less affordable than the sums-on-paper make it appear and it involves raising taxes (or reducing subsidies) for a broad set of taxpayers on moderate incomes.
Even it up in Indonesia?
Last week, Oxfam released a report on Inequality in Indonesia which gave the impression of a vast capacity to increase public spending and redistribution, by focusing on taxing the mega rich. Its “killer facts” included:
If Indonesia had reached its full tax potential in 2015 it could have raised an extra $63 billion, enough to increase health spending 9x over.
The amount of money the richest Indonesian earns annually from his wealth is enough to bring 20 million people out of poverty.
In 2014, $100 billion flowed from Indonesia into tax havens, equivalent to nearly 10x the education budget.
Inequality in Indonesia is high and on the rise. Household surveys show that most of the population consume less than $10 (PPP) a day, while the Forbesrich-list shows 32 Indonesian billionaires. The country only collects about 11 percent of GDP as tax, whereas the IMF estimates it could collect up to 21 percent. So certainly there is a need for more and better taxation in Indonesia, and for it to be more progressive.
But is Oxfam being overoptimistic about the scale of redistribution afforded by tapping billionaires and tax havens?
Wishful thinking about tax
Photo Credit: Oxfam
The Richest Indonesian, Budi Hartono, is worth $8.1 billion. Oxfam calculates that the money his assets generate annually would be enough to “eradicate extreme poverty in Indonesia.” However, this turns out to be based on a misunderstanding (as Laurence Chandy points out below—this section has been updated to reflect his comments).
21 million people remain below the extreme poverty line, in Indonesia and the average poverty gap in 2014 was 1.25 percent. Oxfam calculate that this means that extreme poverty can be eliminated for a little over 2 cents per day, or a total of $182 million, which they note could be more than covered by the $324 million returns from Budi Hartono’s wealth. However as Laurence Chandy points out, this is a mistake; the actual gap is 29c, or $2.2 billion altogether. So it turns out that a 100% tax on Budi Hartano’s income would not bring 20 million people out of extreme poverty, but rather would give them 4c extra per day, raising their incomes by 2%.
Oxfam recommends that Indonesia should raise the top rate of income tax to 65 percent for the 350 or so mega-rich people in the country, introduce a wealth tax and raise inheritance tax. However, it seems unlikely that concentrating fiscal reforms which target just the few at the top would generate anything close to the extra $63 billion implied by the IMF’s estimate of the country’s tax potential. As a very rough calculation, raising the top tax rate to 65 percent on the presumed earnings of Indonesia’s next 32 billionaires (assuming simplistically that they don’t react in any way) could raise an additional $0.9 billion a year. Indonesia’s fuel subsidies in contrast were worth $28 billion but affect many more people, and have been reformed after many false starts.
Wishful thinking about tax havens
As the challenge of fuel subsidy reforms highlights, raising more revenues more progressively means negotiating a politically difficult settlement between governments and citizens. However Oxfam instead point to what they believe are massive flows of untaxed income going offshore: $100 billion flowing from Indonesia into tax havens in 2014.
Photo Credit: Oxfam
This number appears to be wishful thinking. The report indicates the numbers are based on analysis of data from the IMF Coordinated Direct Investment Survey (CDIS), which Oxfam interprets as showing that $101 billion was invested from Indonesia into tax havens in 2015, compared with $53 billion in 2009 (page 22 and footnote 137).
But firstly, the CDIS figures are stocks, rather than flows. And secondly, as far as the IMF data reports the total stock of outward investment from Indonesia to all other countries in 2015 stood at $25 billion.
I think that the source of the $100 billion figure may be a muddle and a mistake. If you look at the CDIS data for inward investment positions to Indonesia in 2015 and add together investment from Singapore, the Netherlands, Mauritius, and small island states like the Seychelles, the total is around $100 billion. If you do the same thing in 2009, the total is around $50 billion. These are stocks, not flows. And they are inward not outward investment positions. If this is the analysis that shows “$100 billion flowed from Indonesia into tax havens, equivalent to nearly 10 times the education budget in that year,” it appears to be a mistake.
Redistribution has a role to play, alongside economic growth in enabling more people to attain prosperity. Negotiating the trade-offs and difficult choices to be made is politically difficult and requires honest debates—not wishful thinking.
In the search for sustainable sources of finance for development, the potential for developing countries to collect more domestic revenues from taxation has risen to prominence in recent years. International tax evasion and avoidance and the role of tax havens have been raised as critical barriers, and transparency is often advocated as a key solution. This briefing offers a short outline of the key issues, terms, and numbers involved.
Misinvoicing is a form of trade-based money laundering involving exporters and importers conspiring to deliberately misreport the value of commercial transactions to customs. The report by Professor Léonce Ndikumana analysed mismatches in international trade data in the UN COMTRADE database for seven country-commodity pairs: gold, silver/platinum and iron ore from South Africa, copper from Chile and Zambia, cocoa from Cote D’Ivoire, and oil from Nigeria. In all seven cases it came to a single conclusion: there were substantial levels of misinvoicing.
But discrepancies in trade statistics are simply not the same thing as customs fraud, and what the report actually revealed is how ordinary trade patterns can be systematically converted into massive misinvoicing estimates. This is not just a minor measurement issue, but is fundamental to global understanding of illicit financial flows.
The great gold heist that never was
Last July UNCTAD published the original report which calculated that “virtually all gold exported by South Africa leaves the country unreported,” accusing mining companies of smuggling billions of dollars’ worth of gold (and implicitly suggesting that the South African authorities had turned a blind-eye).
This was promptly disputed by the South African Chamber of Mines and the South African Revenue Authority. The Chamber of Mines commissioned an independent report from economics consultancy Eunomix which found that (as you might expect) the mining companies and public agencies do report gold exports, just not in the right format for COMTRADE. They found that three quarters of the observed discrepancy could be explained just by looking up the official statistics.
The review concluded that:
In addition to justifying questions on the scientific validity of the UNCTAD study, the lack of effort to find alternative data sources and the lack of alternative hypotheses render acceptable questions about the motives of the report. Indeed, the conclusion that the report sought to prove a tenuous hypothesis by excluding alternative perspectives and approaches, and focusing on a monodimensional empirical analysis without alternative hypotheses and data sources is not unreasonable.
The new report and accompanying note do acknowledge that there are alternative explanations for the discrepancies (such as higher than expected transport costs), but it quickly dismisses them as being implausible. While the language of some of the claims is moderated and a couple of the calculations adjusted, the main conclusions remain unchanged.
Table 1. Misinvoicing estimates, original and revised
Misinvoicing (original)Misinvoicing (revised)What is the change?South Africa gold
$78.2 billion underinvoicing
$57.1 billion underinvoicing
Estimate only until 2010
$17.3 billion overinvoicing
$14.5 billion underinvoiced
South Africa Silver/Platinum
$24 billion underinvoicing
$24 billion underinvoicing
$44.4 billion overinvoicing
$44.4 billion overinvoicing
Cote D’Ivoire Cocoa
$3.7 billion underinvoicing
$3.7 billion underinvoicing
South African Iron Ore
$0.6 billion underinvoicing
$0.6 billion underinvoicing
$89.7 billion overinvoicing
$89.7 billion overinvoicing
[in relation to ‘world’, various periods]
Getting a feel for scale
Why does UNCTAD remain so convinced? Ndikumana says “the sheer magnitude of the estimates suggests that the problem is real and it must be tackled with all the attention it deserves.” Janvier Nkurunziza, chief of UNCTAD's Commodity Research and Analysis Section says that the discrepancies are “simply too large to be caused by simple human error or methodological differences.”
That sounds like circular reasoning to me, particularly as the South Africa case has already demonstrated that very large estimates can derive from inconsistencies in the way that different countries report commodities.
Reading through the report (and its charts), it is hard to judge the relative scale of each case, because they are presented using a bewildering array of secondary axes for overall export volumes (including in some cases, exponential scales). Below is my attempt at setting out the net misinvoicing estimated in each case, relative to overall exports.
Figure 1. Estimate “misinvoicing” vs. overall “world” exports, various periods (%)[the data here is drawn from the revised report and from this article from Professor Ndikumana. in general they relate to the period 1996-2014, or in some cases sub-periods, depending on the commodity.]
Too large not to be real?
Three findings seem to fall into the “sheer magnitude” category: South African gold, South African platinum/silver, and Zambian copper. Yet in each of these cases there is a much simpler explanation.
Gold export from South Africa: massive smuggling or a classification issue?
The report continues to interpret the almost complete mismatch of South Africa’s reported gold exports in COMTRADE as misinvoicing.
Figure 2. “South Africa: Non-monetary gold exports and export misinvoicing (millions of constant 2014 dollars), 2000-2010”[Source: UNCTAD report December version]
The South African Revenue Service and the Eunomix report have already pointed out that the cause for this. Most gold exports from South Africa were, until 2011, classified as “monetary” gold, but partners counted these imports as “non-monetary” gold. However Ndkikumana insists that these gold exports remain unaccounted for. He rejects the approach of reconciling the puzzling data by combining monetary and non-monetary gold records, saying that this would be comparing ‘apples and oranges.’
But apples and oranges are quite different physical commodities. Bars of gold bullion are not—they are considered monetary or non-monetary by virtue of whether they are being held as assets by monetary authorities, and can be classified differently by different countries, and over time. The UK for example reclassified ‘monetary gold’ trade to ‘non-monetary gold’ in 2011, increasing reported imports from non-EU countries by 10 percent at the stroke of a pen.
Silver and platinum exports from South Africa: gaps in the data
The analysis of silver and platinum misinvoicing is unchanged in the revised report. It notes that the overall estimate of misinvoicing is made up of a combination of years when the discrepancy in the trade data is relatively small, and a few years when there are substantial discrepancies.
Figure 3. “South Africa: Silver and platinum exports and export misinvoicing (millions of constant 2014 dollars), 2000-2014”[Source: UNCTAD report December version]
In other words, it describes a scenario where the industry swung from legal compliance, to massive undetected smuggling, and then back again on an annual basis (and that one noticed). This seems unlikely. In particular this story ignores the observation by Dewald van Remsburg at City Press—that the COMTRADE database contains no record of South Africa’s platinum exports in 2000 and 2002, but SARS statistics show normal levels of platinum exports . The UNCTAD study attributes several billions of dollars worth of underinvoicing by exporters to the gap in the COMTRADE data for these two years.
Zambian copper exports to Switzerland: now you see it, now you don’t
The original report estimated that there was systematic overinvoicing of Zambian exports of copper to Switzerland and the UK and systematic underinvoicing to everywhere else, generating a net result of $17 billion of overinvoicing versus the world. It suggested something peculiar and mysterious was going on since on paper the main customer for Zambian copper is Switzerland, but in practice barely any of the metal arrives there.
The revised report recognizes that the exports to Switzerland reflect the role of Swiss commodity trading. The solution it adopts is simply to remove the misinvoicing estimates involving Switzerland from the charts and tables on Zambia copper. Thus the finding is now flipped from net overinvoicing to $14.5 billion of underinvoicing.
This ad-hoc approach of simply ignoring 50 percent of reported exports makes no sense, and is inconsistent with the rest of the report. As Ndikumana argues elsewhere; inconsistencies in recording the destination and origin of products can generate spurious misinvoicing estimates for individual country pairs—which are netted out in the ‘world’ calculation. For example if copper is reported as an export from Zambia to Switzerland, but in practice sits in a bonded warehouse before being delivered to Germany, this would show up as ‘overinvoiced exports’ to Switzerland and ‘underinvoiced exports’ to Germany. Netting the two is the right thing to do, as it reflects that there was in fact no misinvoicing, no illicit financial flow. Ignoring the reported exports from Zambia to Switzerland, as the revised report does, while counting the corresponding import by Germany turns ordinary merchanting trade dollar-for-dollar into “evidence of underinvoicing.”
Too small to tell
The calculations assume transport and insurance costs are 10 percent of product value, and that any deviation from this is over- or under-invoicing. However we know this is not always true: for example last year iron ore exported to China from Latin America or West Africa would get a sales price of approximately 60 $/ton at the Chinese port, and a freight rate of about 9 $/ton. But pricing at $51/ton at point of export this ordinary, legally compliant trade would generate an underinvoicing estimate of 8 percent.
In cases where the overall margin of apparent misinvoicing is slim, there is no basis for confidence that the discrepancies can be distinguished from ordinary transport and warehousing costs. In almost every case in the UNCTAD study the pattern of apparent misinvoicing can be explained with a simpler story:
Cote D’Ivoire cocoa – Cocoa beans are graded, sorted, cleaned, blended, fumigated, and stored in bonded warehouses in Amsterdam before being delivered to European chocolate manufacturers. Is the 8% difference in value a reflection of this, or customs fraud?
South Africa Iron Ore –Iron ore prices were rising till 2009 iron then fell gradually, while shipping costs fell precipitously. Does the observed ‘drastic’ shift from apparent underinvoicing to overinvoicing reflect changing relative transport costs, or were hundreds of alleged secret side deals inexplicably renegotiated?
Copper overinvoicing –Copper Cathode sells at about $5,000 / tonne, while freight shipping rates are measured in tens of dollars. Does the trade data reflect the fact that copper is a relatively valuable good compared to transport costs, or does it reveal general unexplained overinvoicing by copper exporters?
The problems are not just in the UNCTAD report
The report lays out more clearly than any previous study the nature of the data and assumptions used to generate massive misinvoicing estimates. It is clear that simpler explanations are available, involving basic measurement problems and methodological choices. This can’t be ignored any more.
The lessons from this go beyond the UNCTAD study. The UNECA High Level Panel report on Illicit Financial Flows (‘Africa is losing $50 billion to misinvoicing’) uses a similar methodology, and the same country-commodity pairs are strong contributors. In fact, gold, silver, and platinum are the second largest source of alleged misinvoicing in the UNECA study, and almost all of this relates to Southern Africa, where it is now clear that the explanation is much more pedestrian.
Global Financial Integrity (GFI)’s main methodology for estimating trade misinvoicing uses IMF direction of trade statistics (DOTS) representing the aggregate value of all products and commodities. It is likely that it picks up the same issues. This can be seen for example by looking at South Africa-UK and Zambia-Italy exports. In the first case almost all of the discrepancy in DOTS seems to be related to gold, while in the second it is almost all copper.
Figure 5: Comparison of DOTS discrepancy and single commodity discrepancy
Importantly, the UNCTAD report highlights how transit and merchanting trade, and the use of bonded warehouses, can result in large trade data discrepancies arising at a national level (this is a variation of the well-known ‘Rotterdam effect’). Ordinary, legitimate trade can generate a pair of discrepancies involving three countries (for example a single shipment could lead to apparent underinvoicing from Zambia-Switzerland and equal apparent overinvoicing from Zambia-Germany). Ndikumana’s ad-hoc step of excluding Switzerland from the Zambia copper analysis leads to meaningless results. However Global Financial Integrity’s ‘Gross Excluding Reversals’ method is based on the same general principle. GFI argue that perverse discrepancies are evidence of overinvoicing, indicating tax evasion or capital going into the underground economy. Netting it off they say would be “is akin to the concept of net crime”, therefore they set them to zero. It is ignoring these observed discrepancies in one direction that generates the large misinvoicing estimates.
Methodologies and magnitudes—why they matter
Cross border-criminals, money launderers, bribe payers, bribe takers, and tax evaders do hide transactions amongst legitimate trade flows. The problem is real.
However it turns out that the idea that such illicit financial flows can be reliably identified through simple calculations using publicly available data was overoptimistic. The UNCTAD study reveals clearly how these calculations systematically transform records of ordinary trade flows into large misinvoicing estimates.
The revised report was a missed opportunity to check the misinvoicing interpretation against the real-world knowledge of commodity traders and trade analysts, and those who work to investigate and prosecute smuggling, tax evasion, and customs fraud. Instead it trod carefully so as not to disturb the assumptions which hold up the precarious edifice of large misinvoicing estimates.
These estimates do not help to understand the scale and nature of trade-based money laundering, or the broader problem of corruption and theft of public assets. Furthermore, they create perceptions that companies doing international business in developing countries must be getting away with hiding vast illicit flows, while customs, revenue and statistics agencies in developing countries must all be utterly incompetent or complicit. It is hard to see how continuing to place confidence in these estimates and methodologies contributes to solving real problems.
 Thanks to David Mihalyi at the Natural Resource Governance Institute for his help with this calculation.
International debates on taxation and development have been informed by a popular narrative that there is a large ‘pot of gold’ for funding which could be released by cracking down on the questionable tax practices of multinational enterprises, and which could bridge the gap towards funding the sustainable development goals. How much of this is wishful thinking and how much really reflects what we know? This paper looks at the 'big numbers' that have shaped this debate and seeks to clarify the emerging evidence.
Over the past couple of weeks Malawi has become the latest poster child for UK campaigns arguing that changes to the international tax system can deliver outsize returns for development.
Specifically, Action Aid is calling on the UK government to renegotiate a 60-year-old tax treaty. Questions were also raised about this issue in the House of Commons.
The idea that it is time to renegotiate a colonial-era tax treaty seems fair enough — indeed the UK government has already officially stated that this is in process. Action Aid, Christian Aid, and Oxfam have also put forward a helpful discussion document that outlines expectations for responsible corporate tax behaviour.
But there are two problems with this latest campaign. One is that the potential benefits of changing the ways multinational corporations are taxed in poor countries like Malawi are hugely overstated. This distracts attention from priorities higher up on Malawi's agenda, like domestic resource mobilization, strengthening public institutions, and attracting foreign direct investment. The second is that this campaign is worryingly evidence-free. Branding current investors as “tax dodgers” in the absence of evidence may deter the future investors that countries like Malawi so desperately need.
The benefits are overstated
The argument that changes to international taxes could put a major dent in the problem of financing development in Malawi is hugely overstated. In 2013, the stock of foreign direct investment (FDI) in Malawi amounted to US $1.3 billion, while annual inflows were of the order of $118 million. If we assume a 15 percent return on the stock of FDI, annual profits might be in the region of $175 million. This is probably a generous assumption as the Malawi Investment and Trade Centre says the main sectors for FDI are infrastructure and energy projects which can take many years to break even. Also, FDI numbers are likely reported on a historical cost basis rather than current adjusted dollars. Nonetheless, the corporate tax rate in Malawi is 30 percent, and a back-of-the-envelope calculation suggests that we might expect $52 million in corporate income tax from international investors (probably a quarter of this related to UK companies), or $3 for every person in Malawi per year. By comparison, in 2013, aid flows to Malawi were approximately $70 per person.
Increasing the tax take from multinational companies would only make a small difference to Malawian government revenues. Telling people that taxing multinationals more could solve Malawi’s budget crisis undermines the national conversation about the hard choices the government faces on spending priorities.
But there is no specific example of a UK company behaving badly or any estimate of how much money might be at stake from reforming the tax treaty. The only case that is highlighted is the Kayelekera mine, operated by the Australian company Paladin. This mine was a loss-making venture and is shuttered as it is uneconomic to operate at current prices, suggesting that the deal may not have been as generous as some campaigners once believed.
In the absence of any evidence of wrongdoing, it is irresponsible to brand the few companies that invest in Malawi from the UK as undermining the country’s development. Stoking the fire in this way could create reputational and tax risk for the private sector and may deter sorely needed productive investment.
The way forward
Malawi’s problems are not a mystery. Small, landlocked, largely rural and extremely poor, Malawi is a country where less than 10 percent of people have access to electricity. It is at the lower end of the World Bank’s Doing Business Index. In 2013 the “cashgate scandal” revealed large-scale theft of public funds. The UK and other donors that had been covering 40 percent of government spending suspended direct budget support, leading to the government printing money. Inflation is running at around 25 percent.
The Malawian government’s most urgent challenge is to rebuild trust in its public institutions and stabilize its economy. At the same time it needs to develop infrastructure, and improve health care and education.
Describing the challenge is easy enough, but meeting it is hugely difficult. Eliminating a clause in an international treaty will not be sufficient and may not even be relevant. Malawi’s development depends on its government being able to maintain a focus on its priorities, gain public support for difficult choices and improve public resource management.
The role of international organizations
There is always a role for making powerful firms behave better overseas, whether by tackling corruption or improving tax behavior. But to enable the development outcomes we want, we need to shift the conversation to one that takes the challenges and barriers to investment seriously. Campaigning and advocacy organizations have an essential role to play in doing that.
And this needs to happen quickly. The UK might be able to afford a myth-fueled knock-about debate on the tax affairs of big companies, but countries like Malawi and Zambia cannot.