EFTA00317171

Department of Economic & Social Affairs CDP Background Paper No. 24 ST/ESA/2014/CDP/24 December 2014 International Tax Cooperation and Implications of Globalization' Leome Ndikumana ABSTRACT Recent developments in globalization raise important issues regarding taxation policy and economic development. First, trends in capital income tax raise concerns about a pos- sible race to the bottom or harmful competition. Second, lack of tax policy coordina- tion results in large losses in tax revenue due to profit shifting by multinational corpora- tions. These practices undermine revenue mobilization in the least developed countries, which also suffer from capital flight and other forms of illicit financial flows. This paper discusses how improved governance of the global financial system and enhanced harmo- nization in taxation policies may help address these important development problems. Keywords: Taxation; tax evasion; globalization; saving; capital; economic development JEL Classification: E21; H26; O16; O19; F13 Leona. Ndikumana is Professor of Economics and Director of the African Development Policy Program at the Political Econ- omy Research Institute (PERT) at the University of Massachusetts at Amherst, E-mail: cdika@econs.umass.edu. Comments should he addressed by e-mail to the author. Ibis paper was prepared as a contribution to the work program of the United Nations Committee for Development Policy (CDP) on the United Nations' development agenda for the post-2015 era. This research effort aimed at analyzing and proposing solutions to the current deficiencies in global rules and global governance for development. Additional information on the CDP and its work is available at: http://www.un.orgfenidevelopmentidesa/policy/cdp/indcx.shtml EFTA00317171 CONTENTS 1. Introduction 3 Why care about safe havens 11 2. Tax policy in the context of globalization 4 Institutional mechanisms of secrecy 13 Special goals and challenges associated 5. Global conventions and frameworks for tax with globalization 4 cooperation and against tax evasion .. . . 14 Trends and shifts in tax policy regimes 6 Existing frameworks 14 3. Tax competition and gains from international Limited effectiveness of existing frameworks 15 policy coordination 8 6. International tax cooperation and revenue Distortionary effects of taxation 8 mobilization in developing countries.. . . 16 Evidence: do countries engage in tax• 7. Taxation and global public goods 19 based competition over capital 8. Conclusion 21 and savings? 9 References 22 Gains from tax policy coordination 11 Appendix Tables 24 4. Tax competition, tax evasion and safe havens 11 CDP Background Papers arc preliminary documents circulated in a limited number of copies and posted on the DESA website at http://www.un.org/en/development/desa/papers/ to stimulate discussion and critical comment. The views and opinions expressed herein arc those of the author and do not necessarily reflect those of the United Nations Secretariat. The designations UNITED NATIONS and terminology employed may not conform to Department of Economic and Social Affairs United Nations practice and do not imply the ex- UN Secretariat, 405 East 42nd Street pression of any opinion whatsoever on the part of New York, M. 10017, USA the Organization. email: undesa@un.org Typesetter: Nang Setterasi http://www.un.org/en/development/desa/papers/ EFTA00317172 Acronyms ADB Asian Development Bank MFN Most Favoured Nation AfT Aid for Trade MoCS Ministry of Commerce and Supplies AoA Agreement on Agriculture MoF Ministry of Finance ASYCUDA Automated System for Customs Data MoFTR Memorandum on the Foreign Trade Regime CSOs Civil society organizations NGOs Non-Governmental Organizations CV Custom Valuation NPC National Planning Commission DAD Department for International Development, United Kingdom NRB Nepal Rastra Bank DSB Dispute Settlement Body NTC Nepal Telecommunication Corporation DTIS Diagnostic Trade Integration Study ODCs Other duties and charges EIF Enhanced Integrated Framework SAARC South Asian Association for Regional Cooperation FAO Food and Agriculture Organization of the United Nations SPS Sanitary and Phytosanitary Measures FTA Free Trade Agreement SWAp Sector-wide Approach TBT Technical Barriers to Trade GATS General Agreement on Trade in Services TPRM Trade Policy Review Mechanism GATT General Agreement on Tariffs and Trade TRIPS Trade-Related Aspects of Intellectual Property Rights GDP Gross Domestic Product TRQs Tariff rate quotas GTZ German Development Agency UNCTAD United Nations Conference on Trade MS Harmonized System and Development IF Integrated Framework UNDP United Nations Development Programme IFC International Finance Corporation UPOV International Union for the Protection ITA Information Technology Agreement of New Varieties of Plants ITC International Trade Centre WP Working Party LDCs Least Developed Countries WTO World Trade Organisation EFTA00317173 This paper was originated as a contribution to the work programme of the United Nations Committee for De- velopment Policy (CDP) on the United Nations development agenda for the post 2015 era. This research effort aimed at analyzing and proposing solutions to the current deficiencies in global rules and global governance for development. Additional information on the CDP and its work is available at: htto://www.un.orden/development/desa/oolicv/cdaindex.shtml. EFTA00317174 la Introduction redistribution role, enabling governments to support livelihoods for low-income segments of the economy. Globalization is viewed as the "increasing interna- Taxation policy is also an important gauge of equity tionalization of markets for goods and services, the considerations in the policy stance. Finally, taxation means ofproduction, financial systems, competition, is an important tool for promoting domestic saving corporations, technology and industries"(UNCTAD and investment, and for attracting foreign capital. It et al., 2002, Glossary, p. 170). It is associated with is in this context that developments in globalization increasing mobility of factors of production — es- are highly relevant for taxation policy. While other pecially capital —, explosion of financial flows, and dimensions of fiscal policy are important, this paper rapid transmission of technological innovation. focuses on the implications of globalization for tax- The integration of product and financial markets is ation policy. facilitated by worldwide adoption of liberalization There are important issues regarding the links be- policies in product and service markets as well as in tween globalization and taxation policy. First, there the financial system, and the general trend towards is increasing evidence that average taxation rates on removal of regulatory obstacles to economic activity capital income have declined over time in developed (UNCTAD et al., 2002, p. 9). and emerging countries (Devereux et al., 2008). While the increase in trade in goods is the bedrock This raises the question of whether this is a result of of globalization, the most rapid expansion has been deliberate attempts by countries to unilaterally use in the area of finance. Over the span of three dec- their tax policy to undercut each other in order to ades between 1980 and 2012, capital flows grew five attract foreign capital and saving. In other words, times faster than exports. Global trade in merchan- are countries engaging in a "race to the bottom" dises increased by 820% overall or 7.2% annually, or "harmful competition" using their tax policies? from $1,979 billion to $18,214 billion. During the Second, with the increasing mobility of capital same period, global (outward) foreign direct invest- and ease of incorporation of enterprises in foreign ment, for example, increased by 5,290% overall or territories, there is concern about multinational 13.3% annually, from $549 billion to $23,593 bil- corporations (MNCs) engaging in profit shifting, lion" Most of capital flows have been directed to the taking advantages of loopholes in tax policy, gaps in service sector, including banking. For example, over regulatory frameworks, and lack of coordination of the 2005-2007 period, services accounted for 60 taxation policy across countries. This has important percent global investment outflows, although they implications for efficiency and equity. The problem is represented only about five percent of global trade exacerbated by the lack of transparency in the global (UNCTAD et al., 2012, p. 12) . At the same time, financial services, especially in safe havens (Shaxson, while there have been substantial efforts to establish 2011). Third, there is a concern that there is no level and strengthen global frameworks for the regulation playing field in the globalization process, and that of trade in goods, much less has been done in terms the least developed countries (LDCs) especially of coordination of trade in services and finance. are substantially disadvantaged in the allocation of capital and saving. In particular, LDCs suffer large These developments in globalization have impor- losses in tax revenue due to profit shifting by MNCs tant implications for taxation. Tax policy remains a operating in the natural resources, manufacturing, central element of national policy in several ways. and service sectors, while at the same time they face It is the main source of revenue mobilization to fi- severe haemorrhage through capital flight and other nance public service delivery and to support coun- forms of illicit financial flows (AfDB and GFI, 2013; ter-cyclical policy interventions. It has an important Ndikumana and Boyce, 2011a; Shaxson, 2011). Data obtained from UNCTAD's statistical database (on- From a global perspective, taxation policy can also line) at http://unctad.org/en/PagestStatistics.aspx. play an important role in advancing global initiatives. EFTA00317175 CDP BACKGROUND PAPER NO. 24 This is at two levels. At the first level, taxation can In the context of globalization, national fiscal policy generate valuable resources to support the financing design and management is guided by two important of 'global public goods'. At the second level, targeted objectives. The first is to improve the competitiveness taxation can help discipline the production of 'global of national enterprises relative to foreign companies. public bads' such as pollution. Achieving these goals In this respect, fiscal policy uses two main tools: the requires a high level of coordination and political statutory tax rate on capital and corporate profit; and commitment by national governments. the effective marginal tax rate on business income. The second objective is to attract foreign capital and This paper discusses these issues with a view to shed saving while retaining domestic capital in the local light on ways to improve global institutional mech- economy. This objective is challenged by the fact that anisms and frameworks to increase efficiency and tax policy is a sovereign policy and therefore there is equity in taxation in the context of globalization. The no expectation that countries will automatically har- next section describes the main features and develop- monize their policies. In fact, more often than not, ments in tax regimes under globalization. Section 3 tax policies are not harmonized, and this is not new. discusses tax competition and potential gains from international coordination in tax policy. Section The lack of harmonization of tax policy is partly due 4 explores the linkages between tax competition, to the fact that economies are characterized by dif- transparency and the emergence of tax havens as fa- ferent levels of productivity of capital and different cilitators ofprofit shifting, transfer pricing, and other rates of economic agents' intertemporal substitution illicit financial flows. Section 5 reviews the existing between saving and consumption. However, even global institutional frameworks for tax coordination taking into account these considerations, the evi- and anti-tax evasion conventions, examines their dence tends to show that substantial disparities in effectiveness and discusses their potential. Section 6 taxation rates arc not backed by these fundamental examines the implications of international tax coop- characteristics. Take the example of tax on capital. eration for revenue mobilization in developing coun- One would expect that differences in tax rates across tries. Section 7 briefly discusses the potential benefits countries would reflect differences in productivity of from international coordination of taxation policy for capital. Figure 1 suggests that this is not systemati- financing global public goods. Section 8 concludes. cally the case. Fiscal policy in the context of globalization is con- fronted with the reality of increased cross-border © Tax policy in the context of globalization Figure 1 Effective corporate tax rate (EATR) and productivity of capital in the US and EU, 1991 Special goals and challenges associated with globalization Sweden, In addition to its traditional role in the domestic Finland economy, tax policy takes on an expanded role in Denmark the context of globalization. It is a tool for managing Italy the country's trade and investment relations with the Austria rest of the world, including protecting the domestic ■ productivity economy against external shocks. At the global level, France of capital taxation is also a tool for (1) setting up incentives for Ireland ■ EATR discouraging the production of public 'bads such as 0 20 40 60 80 100 120 pollution and (2) for mobilizing financing for public EATR (%); productivity ratio (96) goods. This is further elaborated in Section 7. Source: Sorensen (2000). EFTA00317176 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION capital mobility, following the gradual deregulation tax rates compared to other OECD countries. This, of capital account regimes. If domestic tax rates arc as the argument goes, would be one of the major perceived as being higher than in other countries, reasons why American businesses have been relo- then businesses will be tempted to move abroad cating production abroad, especially in developing either or both their investments and their business and emerging countries to reap the benefits of lower profits. This raises policy concerns as such decisions effective costs of capital and labour. Recent evalua- affect the country's potential for growth and em- tions tend to lend some support to the claim about ployment creation. US tax rates being higher than in comparable coun- The competitiveness implications of fiscal policy tries. In 2013, the average effective corporate tax rate have come to the centre stage in the wake of the 2008 was 39.1 percent in the United States, followed by global financial crisis in developed countries as they Japan at 37% (Figure 2). All the other major OECD struggled to ignite and sustain economic recovery. In countries had lower rates. In the UK, the rate was the United States, the crisis has re-energized claims a full 16 percentage point lower than in the United from the business community and the conservative States (23%). In all OECD countries except Chile, political establishment that American companies arc the tax rates have declined since 2000, and quite penalized by relatively higher statutory and effective substantially in some countries. The United States Figure 2 Effective corporate tax rates in selected OECD countries, 2000-201 3 United States -0.2 39.1 Japan -3.8 r. 36.9 France -3.3 mi 34A Belgium -6.2 33.9 Portugal -3.7 315 Germany -21.8 30.1 Spain -50 30.0 Mexico -5.0 30.0 Australia -4.0 30.0 Luxembourg -8.2 292 Norway 0 28.0 New Zealand -5.0 28.0 Italy -9.5 275 Canada -16.2 26.1 Greece -14.0 26.0 Netherlands -10.0 r. 25.0 Denmark r change -7.0 25.0 Austria (percentage points) -9.0- 25.0 Finland 2000-2013 -4.5 24.5 United Kingdom si 2013 rate -7.0 23.0 Sweden -6.0 22.0 Switzerland -3.7 21.1 Turkey -13.0 20.0 Chile 5 20.0 -40 -20 0 20 Source: OECD, Centre for Tax Policy Administration (online data: hup://vnvw.oecd.orgictor). EFTA00317177 6 COP BACKGROUND PAPER NO. 24 experienced a smaller decline in corporate tax rate through various 'tax planning' mechanisms and out- compared to other countries. right tax evasion (discussed later in the paper). A recent report by PriceWaterhouseCoopers (2013) The differences in effective corporate income tax rates finds that in the past years, effective corporate income across countries could be a result ofmany factors. The tax rates have gone up in the majority of sectors in first is, obviously, the statutory tax rate. However, the United States. For example, the average effective these differences arc also driven by the overall struc- corporate income tax rate for companies in the third ture of the tax regime. In other words, these differ- top quartile in the aerospace and defence industry ences are a result of cross-country variations in both increased by 1.6 percentage point from 32.3% in the tax rate as well as the base. This involves consider- 2010 to 33.9% in 2012 (Table 1). The data also indi- ations on what activities arc taxed or not, what provi- cates that the increase in the burden of taxation has sions are available for tax deductions and allowances, been uneven, falling disproportionately on smaller and differential treatment of income on the basis of companies. To use the example of the aerospace and where it was earned — domestically or abroad. These defence industry, the average effective corporate tax considerations arc central to tax competition; they rate for companies in the bottom first quartile in- arc elaborated in Section 3 further below. creased twice as much as in the third quartile: by 4.5 percentage points from 19.5% to 24% during Trends and shifts in 2010-12. The larger companies have experienced tax policy regimes a relatively smaller increase in the tax burden. The increase in the tax burden should be even smaller The configuration of tax regimes around the world for MNCs, which arc able to take advantage of low has experienced three main developments over the taxation in foreign territories where their branches last five decades. The first was the introduction of and affiliates arc located in addition to tax avoidance the Value Added Tax (VAT), which is now the most Table 1 Effective corporate tax rates in selected US corporate sectors, 2010 and 2012 sector Quartile 2010 2012 Aerospace and defence Q3 32.2 33.9 O1 19.5 24.0 Industrial products and automotive sector O3 34.1 35.2 O1 16.4 20.4 Automobile sector O3 35.5 34.4 O1 16.1 18.4 Chemicals O3 32.1 33.9 O1 20.8 23.0 Transportation and logistics O3 38.3 38.5 O1 8.7 15.5 Industrial manufacturing and metals O3 33.6 36.0 O1 22.9 24.1 Source: Price Waterhouse Coopers 12013). EFTA00317178 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION widespread form of consumption tax. The ration- Under the 2005 United Nations Millennium Project, ale for this form of taxation was that it is the least a minimum of 4 percentage-point increase in the tax distortionary way of taxing private consumption. to GDP ratio was deemed necessary for developing The second major development has been the general countries to achieve the millennium development lowering and flattening of statutory income tax rates goals. This meant that countries were expected to on high income individuals and corporations (Bird, raise their tax/GDP ratios from an average of 17-18% 2012). The third noteworthy development is a recent to 22%. This goal proved to be rather ambitious and push for more equity considerations in tax policy. even unrealistic. In fact, no LDC achieved this tar- These changes and trends reflect, to some extent, get. In 2011, the IMF recommended a less ambitious shifts in views of what good tax policy is within the goal of 2 percentage increase in the tax/GDP ratio, academic community and the policy arena. and suggested that most countries could achieve this increase with VAT alone "with no great effort" (Bird, In the 1960s, it was all about income tax. Under 2012, p. 8). what is referred to as Development Tax Model 1.0, progressive comprehensive personal income tax was More recent debates about taxation regimes exhib- deemed to be the ideal tax regime (Bird, 2012). In it increasing attention to the fiscal exchange and particular, such a regime was considered especially equity dimensions of taxation. Specifically, this is appropriate and preferred for developing countries illustrated by reforms in the tax system that seek to (Bird, 2012; Bird and Zolt, 2005; Kaldor, 1963). In- achieve a better balance between resource mobiliza- direct consumption tax was considered as 'necessary tion and income (re)distribution through changes in evil'. International and sub-national aspects of taxa- corporate income tax, personal income tax, tax on tion were relegated to the margin and were not con- wealth, and others. sidered important in tax policy design. This model The evidence, however, shows that these shifts in of taxation eventually proved ineffective in helping taxation regimes have not produced commensurate developing countries in the mobilization of tax reve- effects in effective tax revenue collection. In fact, the nue. Tax to GDP ratios did not increase, which was evidence indicates substantial 'fiscal revenue inertia' an important cause of the fiscal challenges faced by (Bird, 2012) and there has been little progress in developing countries in the 1980s in addition to ex- raising tax/GDP ratios, especially in sub-Saharan ternal debt crisis. Africa (Table 2). The leading region in terms of In the 1980s, the thinking on taxation underwent growth of tax/GDP ratio is developing Asia where an important shift in the context of market-oriented the ratio grew by nearly 3 percent annually during policy reforms enshrined in the so-called Washing- the 2000-12 period. However, this region continues ton Consensus. The prescription was that a broad- to trail other regions in tax mobilization, with a based low tax rate model — Development Tax Model 21.7% tax/GDP in 2012 (up from 15.4% in 2000). 2.0 — was the most appropriate for developing and In Sub-Saharan Africa, there has been virtually no change in the tax/GDP ratio over the past decade. developed countries (Bird, 2011). It is in this con- The best performers in this respect are Latin America text that the preference shifted to VAT as the more and the Middle East and North Africa with ratios preferable form of taxation. However, like under above 30%. Model 1.0, the premise remained that "more tax is better"; thus, the objective remained to increase Several factors have been advanced to explain the tax revenue. Note, however, that even with the shift poor performance in tax revenue mobilization in de- towards VAT, income taxes remained important. veloping countries. These include lack of economic What changed was that the rates were declining, as transformation that perpetuated the dominance of were tax incentives, but the bases were broadening. low-tax generating sectors such as agriculture, and EFTA00317179 8 COP BACKGROUND PAPER NO. 24 Table 2 General government revenue in developing regions, percentage of GDP Annual Average change Group 2000 2005 2010 2011 2012 2000-12 2000-12 (%) Developing Asia 15.4 18.4 20.5 21.5 21.7 18.9 2.9 Latin America and Caribbean 24.5 27.2 301 30.9 31.3 27.7 2.0 Middle East and North Africa 30.5a 40.4 34.7 37.8 37.8 36.9 2.2 Sub-Saharan Africa 25.9 27.6 25.4 28.6 27.9 26.8 0.6 For comparison: Emerging market and 23.6 27.6 27.0 28.3 28.3 26.6 1.5 developing economies European Union 44.7 43.6 43.5 44.1 44.3 43.8 -0.1 Source: IMF, World Economic Outlook database, accessible online at: httryilwww omf ors/external/nehtfiteeen/2014/01/weedetehnelex Atp Note a: In 2002. inefficiencies in tax administration, some of which In addition, the evidence also indicates 'fiscal struc- are due to lack of technical capacity. In the spirit of ture inertia" (Bird, 2012). Despite the various chang- Kaldor (1963), it may be argued that taxation has es in the tax rates and legislations, there has been no not increased as expected "because it is seldom in the major change in the structure of the tax system. In interest of those who dominate the political institu- particular, the share of consumption taxes — share tions to increase taxes" (Bird, 2012, p. 8). of VAT and customs revenues in total tax revenues Moreover, performance in tax revenue mobilization -- has not substantially increased following the in- reflects the degree ofcompliance by tax payers, which troduction of VAT, as increases in VAT revenues in turn is influenced by the public's perception of the have been offset by declining customs revenues due efficiency of utilization of resources as illustrated in to trade liberalization (MartinezNazquez and Bird, the supply and quality of public services. In general, 2011). As for personal income tax collection, there accountable states have more leverage in mobilizing is no systematic common trend across countries; the tax revenue. In particular, successful strategies for ratio of personal income to GDP has increased in raising tax revenues must be backed by enhanced some countries and decreased in others (Table Alin rule of law, reduction of corruption, improved tax the Appendix). The same goes for corporate income morale, and contraction of the shadow economy. tax as a share of GDP (Table A.2 in the Appendix). Obviously these are not easy to accomplish, but "some countries may find it easier to do such things than finding oil — and they may well be better off by doing so since oil wealth may solve the revenue El Tax competition and gains from international policy problem only at the cost of exacerbating substan- tially the governance problem" (Bird, 2012, p. 8). In coordination fact, in the case of developing countries, those that 'have found oil' have performed worse in tax revenue Distortionary effects of taxation mobilization than their less 'lucky' non-oil counter- The substantial variations in statutory and effective parts (see Ndikumana and Abdcrrahim (2010) for tax rates across countries suggest that there arc scopes evidence in the case ofAfrican countries). for competition for capital and savings on the basis EFTA00317180 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION of fiscal policy. These disparities may, in fact, be a taxed as residents on income earned from domestic result of active attempts by governments to compete sources. If all countries adopted the same approach, over mobile capital and savings. This implies that then marginal intertemporal rates of substitution as globalization increases the distortionary effects of well as marginal products of capital would be unaf- taxation. In the context of a closed economy, tax- fected by tax considerations and savings and capital ation can create a wedge between consumer-saver's would be allocated according to country-specific marginal intertemporal rate of substitution and the fundamentals; taxation would not be distortionary producer-investor's marginal productivity of capital. in an open economy context. But in practice, there is This can affect the allocation ofcapital across sectors no coordination in foreign income taxation. and activity. The second possible dimension of tax competition is In the open economy context, there arc two addi- the treatment of debt and equity in taxation. Corpo- tional potential distortions due to taxation (Razin rations can (legally) use clever financial accounting and Sadka, 1991). Under globalization, residents in to take advantage of allowances for deduction of any country may engage in rate of return arbitrage interest payments not only by increasing the use of on capital (firms) and saving (households and firms) debt relative to equity, but also through intra-corpo- on the basis of differences in taxation between their ration lending to minimize the overall tax burden. home country and the rest of the world. Their ob- The latter is an avenue for 'thin capitalization' as well jective is to maximize the returns to savings and as profit shifting across territories, resulting in overall capital regardless of the country where they choose lower effective tax payments for the corporation as a to locate their investments and channel their savings whole. Therefore, the data on effective corporate tax or profits. Differences in taxation, therefore, can rate may be misleading with respect to the level of create disparities in the intertemporal marginal rate statutory taxation in a country. This also means that of substitution, which may result in misallocation countries have more tools at their disposal when they of savings across countries. Similarly, differences in use tax policy to compete over capital and savings. taxation may drive disparities in marginal product of capital, resulting in misallocation of capital or Evidence: do countries engage in investment across countries. tax-based competition over capital If countries choose to compete over capital and sav- and savings? ings using fiscal policy, their tool kit include more The question of whether countries effectively engage than the rate of taxation. In addition to setting in tax-based competition has been motivated, in the tax rate, governments can choose what to tax, part, by the substantial variations of tax rates across when and how much to tax it. From the tax pay- countries as well as the steady decline in effective er's perspective, this affects the taxable income and marginal tax rate on capital and corporate profits the tax base. There arc two important dimensions (Devereux et al., 2008). Obviously, the decline in besides the tax rate along which governments can the tax rate is a concern because it implies loss in compete to attract and retain capital and savings in government revenue. But, at least in principle, these the context of globalization. The first is the treat- losses may be compensated by gains arising from ment of foreign-earned income. Here governments increased economic activity due to inflows of foreign can choose between two approaches. The first is the capital if, in fact, the tax provisions do succeed in residence-based taxation whereby residents are taxed enticing increased capital inflows. on their world-wide income, regardless of whether the income is earned at home or abroad. Foreigners The research community has attempted to shed arc not taxed at all in this approach. The second is light on the question above by combining theoret- the source ofincome approach where residents are not ical modelling and empirical analysis to search for taxed on foreign-earned income and foreigners arc evidence of effective tax competition (Devereux et EFTA00317181 CDP BACKGROUND PAPER NO. 24 al., 2008; Huizinga and Laeven 2008; Marceau et be displaced due to disparities in taxation policies al., 2010; Paeralta et al., 2006; Wilson and Wildasin, (Dcsai et al., 2006). There are also possibilities of 2004). To get a handle on the question, one must misallocation of capital and savings across countries consider the interplay between the decisions by the as discussed earlier. Information plays a key role in government regarding taxation and the reactions of the decisions by firms and savers to allocate capital private sector actors (firms and individual savers) and saving. This happens at two levels. First, accurate with regard to the levels and allocation of capital and information on the true content of taxation policy saving. The interplay can be conceived as a two-stage — statutory as well as effective tax rates — is impor- game between private actors and the government. tant in the determination of the optimal level and This is summarized in Figure 3. location of capital. Second, the extent of disclosure of information, or transparency, affects incentives of The outcomes of these interrelated decisions by the firms and savers in determining the location of eco- government and private sector actors arc critically nomic activity (capital), savings and profits. important for the relative economic performance of countries with accompanying welfare implications. The literature on tax competition provides some These decisions imply that economic activity may consistent evidence that demonstrates the important Figure 3 Government, firms, savers and taxation: a game theoretical representation 2" stage High statutory rate Level of capita (investment) ► Low Tax rate Effective Firms Location of Home marginal rate capital Government Abroad Breadth Location of Home profits Tax base Abroad Exemptions and Arms-length exonerations Transfer price High High Level of saving Low Short-term Households Term structure (Savers) of saving Long-term Home Location of saving Abroad Source:Author'sdesign. EFTA00317182 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION role of globalization. The evidence confirms that between gains from harmonization and payoffs from capital and profits have become more mobile across differentiated regimes. In making these decisions, countries, as illustrated by the massive capital flows economic and financial calculus is often be trumped towards both developed and developing countries, by political considerations. This may explain why although the lion share is still at the advantage of ad- international conventions and protocols on taxation vanced economies. The evidence also confirms that take long to design and are difficult to implement governments do use taxation policy to compete over and enforce. This is further discussed in Section 5. capital, profits and savings. Among the tools that are Coordination and harmonization of tax policy may at the disposal of the governments, the key factor take place at the regional and international levels. that seems to be determinant in tax competition is The gains from harmonization in terms of revenue the statutory tax rate. In contrast, the effective mar- mobilization are maximized if all countries were to ginal tax rate seems to play a minor role (Devereux agree to exchange full information on taxation and et al., 2008). systematically enforce a common regime such as a The analysis in the empirical literature indicates that residence-based taxation. However, the gains from tax competition has been enhanced by the increasing coordination depend on other factors underlying the deregulation of capital flows (Devereux et al., 2008). domestic economies and the regulation of exchange In the case of developing countries, capital account between countries. In particular, a key determinant liberalization occurred in the context of the general of the feasibility of coordination and the gains from push for economic liberalization from the 1980s. it is the degree ofcapital mobility across countries. In In the developed world, the major change was the the presence of perfect capital mobility at the global culmination of the European integration into a level, the gains from regional coordination appear to common currency, which provided an environment be rather small (Sorensen, 2004). Regional coordi- for near-complete mobility of capital. In the context nation would be justified if the set of countries in of closed capital account or restricted capital flows, the region are more integrated among each other, but tax competition is less effective in moving capital relatively closed vis-a-vis the rest of the world. Given between countries. But this holds only for transpar- the general trend towards capital account deregula- ent and honest movements of capital; illicit capital tion, harmonization efforts at the regional level need movements arc generally independent of the degree to be effectively coordinated with initiatives at the of capital flow regulation (Fofack and Ndikumana, international level. 2013; Ndikumana and Boyce, 20116; Ndikumana et al., 2013). 4 Tax competition, Gains from tax policy coordination tax evasion and safe havens The increased capital mobility has motivated debates on the need for global and regional cooperation Why care about safe havens on corporate income and capital taxation policies The discussion of coordination of taxation policy (FitzGerald, 2002). The objective is to avoid the "race in the context of globalization cannot be complete to the bottom" whereby in an attempt to lure capital without an analysis of the role of safe havens, or tax to their home countries, governments undercut each havens, secrecy jurisdictions, or offshore financial other's capital income tax mobilization. Coordina- centres (OFCs). These terms are used often inter- tion of tax policy is both a technical and a political changeably although they do not mean the same process. It is critically contingent on systematic and thing. So, for example, while it is typically presumed efficient exchange of information on taxation. It also that most illicit financial flows are concealed in small requires sensitive sovereign decisions about trade-offs tropical islands called safe havens, a substantial share EFTA00317183 12 COP BACKGROUND PAPER NO. 24 of the funds are, in fact, located in financial centres accounts for income and expenditures, it is likely in major OECD countries. But the latter are rarely, if that the standard measures of welfare and inequality ever, referred to as OFCs or tax havens. Thus far, the as well as cross-country distribution of wealth may discussion in this paper on how tax regimes induce provide inadequate representation of the actual ex- and affect the mobility of capital, profits and sav- tent of inequality; they may overestimate or under- ings has not considered the legal and transparency estimate it. (Zucman, 2013). aspects of transactions. Yet, transparency and legal- ity of financial flows is central to understanding the The attention to tax havens is further motivated by recent explosion of financial flows around the world, the linkages with corruption in both developed and a substantial part of which goes towards or transit developing countries. Secrecy jurisdictions provide through tax havens. a safe haven for corrupt rulers to hide stolen assets, including funds obtained through embezzlement But why should we care about tax havens? There are of the proceeds from natural resource exploitation several reasons. First, due to the services that secrecy and trade. For example, it is estimated that up to 8 jurisdictions offer to capital holders, they facilitate percent of all petroleum rents from oil-rich countries the transfer and concealment of capital including with weak institutions end up in private accounts in illicitly acquired funds. This has emerged as a major OFCs (Andersen et al., 2012; Hebous and Lipatov, issue for developing countries in the context of de- 2013). By facilitating the transfer and concealment bates on development financing and governance. But of corruption-related funds, tax havens undermine developed countries have also begun to pay attention governance in general (Torvik, 2009). They may also to the problem of secrecy jurisdictions because of the have a negative impact on tax regimes, as they pro- substantial revenue losses incurred through profit vide incentives for rulers to devise tax regimes that shifting, transfer pricing and other illicit transac- facilitate profit shifting. As a result, tax compliance tions (Bandsman and Beetsma, 2003; Sikka and is undermined as safe havens facilitate tax avoidance Willmott, 2010). It is estimated that developing and tax evasion by MNCs and the political and countries are more vulnerable to the impact of safe economic elites. This further undermines tax morale havens in the sense that they are less institutionally through negative demonstration effects (Fjeldstad et and technically equipped to address tax evasion and al., 2012). Indeed, if neighbours do not pay taxes, incur proportionately higher revenue losses (Hamp- ton and Christensen, 2010; Hebous and Lipatov, and especially if they happen to be rulers, then there 2013; Shaxson, 2011). Thus safe havens are central to is less incentive for a regular resident to honour his/ debates on taxation policy and development financ- her tax obligations. ing for developing countries. There are, however, voices that have argued that Safe havens also deserve attention due to distribu- there are some positive effects associated with tax tional and equity implications of their operations. havens. It is argued that secrecy jurisdictions and Part of the massive amounts of capital held in tax tax havens enhance competition in neighbouring havens belong to the economic and political elites of countries (Rose and Spiegel, 2007), and that they developing countries, who, in addition to acquiring may even have positive welfare effects by providing most of it illicitly, do not pay taxes on the earnings opportunities for investment by firms fearing high from the underlying assets. This implies substantial taxes and expropriation in corrupt countries (Hong regressive taxation and a relatively higher burden and Smart, 2010). But these alleged potential bene- of taxes on the middle class. Thus, safe havens in- fits pale in the face of the devastating negative effects directly contribute to worsening income inequality arising through the drainage ofresources (Ndikuma- in developing countries. In fact, given the massive na and Boyce, 2011a; Reuter, 2012; Shaxson, 2011), amounts of wealth that is channelled through safe deterioration of governance in the public sector and havens, and, therefore, not incorporated in national erosion of business ethics. EFTA00317184 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION Institutional mechanisms of secrecy This is summarized in Figure 4. Secrecy is provided through two main mechanisms. The first is outright Tax havens thrive on secrecy. The key service they anonymity whereby no meaningful information on sell to their clients is the promise to withhold all the the beneficial owner of an asset, transaction, or com- information pertaining to their identity and the char- pany is recorded during the initiation of a transac- acteristics and outcomes of their business activities. tion, the establishment of a company or the opening That is their main capital, and they work hard to of a bank account. Economic units established in preserve and protect it even in the face of increasing this context are nominative and often do not even pressure from the global community and individual undertake any activities in the territory where they major countries — especially the United States — to arc domiciled. These 'shell companies' arc created to lift their veil of secrecy. Thus, safe havens invest heav- serve as vehicles for transfer pricing, transfer of illicit ily in undermining financial transparency. Financial funds and other activities, which may include legal transparency obtains when "every actor and trans- as well as illegal operations. The second mechanism action within a system can be traced to a discrete, is through a web of legal ownerships involving a identifiable individual" (Sharman, 2010, p. 127). tangled inter-jurisdictional web of interlocking rela- Secrecy jurisdictions and tax havens arc able to pro- tionships. There arc two key features of these mech- vide protection to their customers through complex anisms. The first is what we may call the chameleon institutional mechanisms that establish intricate structures of shell companies in the sense that these layers of secrecy, and make it difficult to link illicit companies can be modified, restructured, and re- proceeds to the predicate crime and the ultimate named expeditiously to evade any inquisition by the beneficiary; that is, linking crime to the criminal. regulator or law enforcement authorities. The second Figure 4 Tax havens and layers of secrecy Objectives and Locus of secrecy Mechanisms and tools implications Limited liability Shielding owner's Corporate secrecy identity; facilitating Shell corporations international Opaque ownership transactions Banking secrecy Funds transfer without Bank-client protection Correspondent banks true beneficiary's identity Lawyer-client privileges Company run by Legal Counsel Legal protection Offshore Trusts Secrecy laws Legal protection; Flee clause Swift relocation Source: Author's design. EFTA00317185 14 COP BACKGROUND PAPER NO. 24 is the mobile jurisdiction of the companies whereby by proportional increase in tax revenue because of the domiciliation of the company can be changed at these leakages facilitated by tax havens. will in no time to evade law enforcement and crim- Rules and regulations in developed countries are inal investigation. These mechanisms are made pos- evolving in response to the increasing evidence on sible by the lax legal systems and regulations in the the explosion of tax evasion and illicit financial secrecy countries. They are also perpetuated thanks flows. But progress is slow and uneven. As a result, to the immense economic power of the companies important discrepancies remain in the institutional and individuals that hold wealth and channel their frameworks, and these differences are exploited for transactions through these territories. the purpose of tax evasion, profit shifting, transfer In the popular press, the notion of secrecy juris- pricing and other forms of illicit financial transac- dictions and tax havens is typically associated with tions. So, for example, whereas all OFCs regulate corporate service providers, the US and the UK do palm-fringed tropical islands such as the Cayman not. It is possible that this reflects the influence of Island, Bermuda, and others. It also refers to terri- the interest groups over the regulators in states like tories with loose governance such as Somalia, which Nevada and Delaware that are known as tax havens are used as transits for illicit trade and financial (Sharman, 2010). It is clear that there is ample room transactions. But recent evidence has shown that for improvement in coordination. large OECD countries are also guilty of harbour- ing banking secrecy, and are both conduits and victims of substantial tax evasion (Hampton and Christensen, 2010; Sharman, 2010; Shaxson, 2011).2 Global conventions and Moreover, surprisingly, it is actually the well gov- frameworks for tax erned countries that tend to become tax havens and cooperation and against that benefit the most when they do so (Dharmapala tax evasion and Hines, 2009). This is contrary to conventional wisdom where large advanced economies are viewed Existing frameworks as having superior legal environments and as being The expansion of activities in tax havens and the ex- the vanguards of transparency and good governance. plosion of illicit financial flows over the past decades This conventional belief is increasingly challenged. have prompted a push for establishment and con- solidation of international regulatory frameworks The use of tax havens has been facilitated by the in- to increase transparency or rather to combat secrecy creasing complexity of the structure of MNCs and and enforce responsible banking and trade practices. their multiple-domiciliation characteristics. Being Efforts have been initiated at both national and glob- located in multiple territories with different regula- al levels on a bilateral as well as multilateral basis. tory frameworks with regard to taxation, banking laws, and rules governing business operations in As the lion share of tax evasion and illicit financial general provides incentives and opportunities for tax flows is orchestrated by or through large companies, evasion. Indeed, larger firms with substantial foreign the first area of focus is the enforcement of standards operations benefit the most from using tax havens on corporate governance. The recent global financial (Desai et al., 2006). The implication is that growth of crisis revealed that there arc widespread and deep the private business sector may not be accompanied shortcomings in corporate governance, especially the lack of reliable checks and balances capable of enforcing responsible corporate practices. In this 2 More information is available at Tax Justice Network (www.taxjustic4.net.), including ranking of territories by context, the main instrument to address this prob- degree of secrecy ('financial secrecy index). lem at the global level is the OECD Principles on EFTA00317186 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION Corporate Governance, especially chapter VI which Such collaboration can, in principle, enable tracking specifies that "the corporate governance framework of the sources, amounts, destination, and owners of should ensure that timely and accurate disclosure financial transactions around the globe. is made on all material matters regarding the cor- Globally, the overarching framework is the United poration, including the financial situation, perfor- Nations Convention on Against Corruption (UN- mance, ownership, and governance of the company" CAC), whose aim is "to promote and strengthen (OECD, 2004, p. 24).3 measures to prevent and combat corruption more Another area of attention is anti-money laundering, efficiently and effectively; to promote, facilitate and which is an important channel of illicit financial support international cooperation and technical flows (R. Baker, 2005). In this context, the rec- assistance in the prevention of and fight against cor- ommendations by the Financial Action Task Force ruption, including in asset recovery; and to promote (FATF) constitute the global standards recognized integrity, accountability and proper management of internationally against money laundering and ter- public affairs and public property" (United Nations, rorist financing. These recommendations are aimed 2003, p. 7). The Convention provides a frame of at increasing transparency and providing member reference for anti-corruption policies at national and countries with a framework and guidance on how regional level, such as the African Union Conven- to prevent all forms of illicit use of their financial tion on Corruption. systems! In the same context, Basel Core Principles At the bilateral level, countries have been establishing provide a framework for banking supervision that agreements to facilitate exchange of information for can also contribute to reducing the use of the finan- the purpose of combatting tax evasion, which also cial system for illicit purposes, although this may can help curb illicit financial flows. In this context, not be the explicit goal. In the same vein, the con- Tax Information Exchange Agreements (TIEA)6 ventions on securities regulation, notably the IOS- have proliferated in recent years. But they remain CO Multilateral Memorandum of Understanding, concentrated among OECD countries whereas de- provide a comprehensive framework for cooperation veloping countries have been left on the margin. For and collaboration among world securities regulators example, only Mauritius has a TIEA in Africa. in the exchange of information (IOSCO, 2012).5 Limited effectiveness of existing 3 The OECD Principles on Corporate Governance were re- leased for the first time in May 1999 and were revised in frameworks 2004. They constitute "one of the twelve key standards for The effectiveness of the various conventions and international financial stability of the Financial Stability Board and form the basis for the corporate governance agreements on cooperation in taxation policy has component of the Report on the Observance of Standards been limited and uneven. For multilateral frame- and Codes of the World Bank Group." OECD: http works, the implementation is often hampered by www.oecd.ors/cornorate/oecdnrincinlesofcorporategov- the lack of coordination among parties to the con- ernance.hun. ventions or agreements and lack of mechanisms of Details on the recommendations can be found on FATF website at: accountability to penalize failure to cooperate. Bi- hccp://www.facf-gafi.org/topicsifatfrecommendations/ lateral agreements also have their limitations. One 5 See, especially, paragraph 7 (b)ii of the IOSCO Memo- important challenge is that operators in tax havens randum of Understanding. Created in 1983, the IOSCO are able to take advantage of the complex layers of gathers the world's securities regulators to set and enforce standards for the securities sector. It "develops, imple- ments, and promotes adherence to internationally recog- website at http://www.iosco.orgiabouti). nized standards for securities regulation, and is working intensively with the G20 and the Financial Stability Board 6 See OECD: http://www.oecd.orgictp/harmful/tazinfor- (FSB) on the global regulatory reform agenda." (IOSCO, mationexchangeagreementstieas.htm EFTA00317187 COP BACKGROUND PAPER NO. 24 secrecy and intricate legal machinery to make dis- revenue. It has been demonstrated in various reports covery of criminal financial activity difficult and and analyses that developing countries are lagging prosecution even harder. Moreover, tax evaders are behind a number of important development goals, able to stay one step ahead of the regulator and the and that a key reason for this is the shortage of fi- investigator. They can shift shell companies, bank nancing to meet their development needs. In light accounts and other transactions to territories that are of the discussion in this paper, international tax not yet covered by treaties. As a result, the TIEAs cooperation can be a tool for helping developing have not yet produced a significant decline in tax eva- countries in addressing this critical constraint to sion or meaningful repatriation of funds. The initial economic development. Three important avenues impact ofTIEAs seems to be a relocation of funds or can be singled out: impact on domestic investment; redirection of new illicit financial flows across juris- effects on tax revenue mobilization; and effects on dictions (Johannesen and Zucman, 2012). allocation of official development aid. Moreover, coordination of efforts to fight tax havens The analysis in this paper suggests that the current is challenging because not all tax havens are created configuration of the global financial and taxation equal. The group includes large and small offshore systems has detrimental effects on efforts by develop- financial centres, including some in poor nations ing countries to increase their domestic investment (Rawlings, 2005). Determining how to sequence as a means of accelerating economic growth and global action is difficult. But at the same time, unless development. In particular, the proliferation of tax action is undertaken at multiple fronts, it is difficult havens and their facilitation of tax evasion and il- to make a substantial impact. It seems, therefore, licit financial flows undermine domestic investment that the effectiveness of efforts to fight tax evasion in developing countries. On the domestic front, tax is bound to be limited in the absence of a concerted evasion facilitated by tax havens creates incentives approach to take on all safe havens at once through for channelling domestic capital abroad rather than a 'big bang' multilateral intervention (Elsayyad and investing in the home country. This affects both Konrad, 2012). In fact, fighting a subset of tax ha- honestly acquired capital and stolen capital that ends vens may actually make the remaining ones more up fleeing developing countries towards safe havens. profitable as activities shift from safe havens that LDCs continue to lose massive amounts of capital are under pressure to the ones not covered by the annually through capital flight and other forms of intervention. But the question remains as to how to illicit financial flows, most of which are motivated organize such a 'big bang' combat against all safe ha- by tax evasion (AfDB and GFI, 2013; Henry, 2012; vens, especially given that it is not even possible for Kar and Cartwright-Smith, 2010; Ndikumana and all stakeholders to agree on a comprehensive ranked Boyce, 2011a; Reuter, 2012; UNDP, 2011). list of safe havens. As can be seen in Table 3, developing countries are facing severe financial haemorrhage through capital flight and other forms of illicit financial outflows in- 6 International tax cooperation cluding corruption related outflows, proceeds from and revenue mobilization in trade in illegal goods and services, and profit shifting developing countries by MNCs. Global Financial Integrity estimates that during the period 2002 to 2011, developing coun- The foregoing discussion on taxation and globali- tries as a group have lost about $6 trillion through zation has important implications for developing illicit financial flows. A substantial fraction of these countries, especially the least developing countries outflows occur through misinvoicing of imports and (LDCs) that face special challenges in taking ad- exports. Most of these outflows are domiciled in safe vantage of globalization and mobilizing domestic havens where their owners take advantage of low or EFTA00317188 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION no taxation, and, most importantly, extreme secrecy transparency in safe havens, inadequate reporting of practices that protect their identity and the source company operations and profits (especially no coun- of their wealth. The leakage of financial resources try-by-country reporting), and lack of coordination through illicit financial flows undermines domestic and exchange of tax-related information across coun- saving in developing countries and, therefore, exac- tries. While it is difficult to obtain a precise estimate erbates the financing gaps faced by these countries. of the losses in tax revenue incurred by developing The resulting capital shortage undermines the ability countries through tax dodging by MNCs, evidence of these countries to achieve and maintain high lev- from case studies suggests that these losses arc large els of investment and growth. in absolute terms and relative to other meaningful economic aggregates. Christian Aid estimated that The second avenue of impact of international tax co- losses in corporate taxes to developing countries due operation on developing countries is directly through illicit practices by multinational corporations are in the capacity to achieve their potential in government the order of $160 billion per year, which exceeds the revenue mobilization through tax and non-tax reve- total amount ofofficial aid to all developing countries nue. This is achieved in two fundamental ways. The (Christian Aid, 2008, p. 3). The practice of tax eva- first is by ensuring that international actors operat- sion is facilitated by profit shifting by MNCs through ing in developing countries pay their taxes. This is transfer pricing. This is especially prevalent in the especially the case for multinational corporations natural resource sector. To illustrate, in the case of which are notorious at using various legal and illegal Zambia, the Extractive Industry Transparency Initi- mechanisms to doge taxes in the countries where ative (EITI) found that while mining companies paid they operate. Tax evasion and tax avoidance by $463 million in taxes to the government, there were multinational corporations are facilitated by lack of $66 million of "unresolved discrepancies" between Table 3 Illicit financial flows from developing countries (Billions of dollars) Region Cummulative illicit flows Recorded external capital inflow? Illicit financial Capital ODA FDI External flows: GFI flight: TJN (net annual (net annual debt estimate? estimatesb flows) flows) stock 2002-2011 1970-2010 2011 2011 2011 Africa 555.8 517.9 51.2 46.4 391.5 SSA 487 361.7 47.5 41.2 297.6 MENA 684.5 963.2 15.5 15.9 162.9 LAC 1130.7 1375.5 11.4 145.1 1133.5 East Asia and Pacific 1974.3 1881.7 7.8 339.8 1286.6 Central Europe and Asia 1273.9 1509.9 10.7 73.8 1095.3 South Asia 375.9 60.7 16.7 40.3 461.8 Developing world 5889.5 6152.8 131.8 735.2 Sources: a Illicit financial flows are from Global Financial Integrity (Kar and LeBlanc, 2013); b Capital flight estimatesare from TaxJustice Network; these measures do not include trade rnisinvoicing, and; c Capital inflows are from the World Bank's Global Development Indicators, complement- ed with data from UNCTAD's online statistical database (http://unctad.orgien/Pages/Statisbcs.aspx). Notes: SSA- sub-Saharan Africa; MENA - Middle East and North Africa; LAC Latin America and Caribbean. EFTA00317189 COP BACKGROUND PAPER NO. 24 actual payments and companies' tax liabilities in the countries and using data on capital flight over the same year (Sharife, 2011)? The main mechanism of period of 1970-2004 from Ndikumana and Boyce tax dodging is transfer pricing. The EITI report notes (2008)9, he estimates that this group of countries was for instance that half of copper exports earmarked losing about $6 billion per year in tax revenue. More for Switzerland never made it there, "disappearing in recent estimates of capital flight from Africa show thin air". The price of copper in Switzerland was six that the phenomenon has continued and even accel- times higher than in Zambia and corporate tax rates erated over the past decades. By 2010, the continent were lower; thus export earmarking for Switzerland had experienced a cumulative outflow of unrecorded implies substantial profits for the companies involved capital in excess of $1.3 trillion in constant 2010 dol- in the copper trade. As a result of these profit shifting lars (Table 4). An important mechanism of capital and transfer pricing mechanisms, Zambia may have flight is trade misinvoicing, especially exports under- lost tax revenue that is nearly equal to its total GDP invoicing which accounted for $859 in unrecorded in 2008 (Sharife 2011).8 outflows in the sample of 39 African countries over the four decades. Extrapolating FitzGerald's results In addition to maximizing tax revenue through curb- on the basis of the updated estimates of capital flight ing of tax dodging by multinational corporations, presented in Table 4, we find that capital flight may developing countries can also mobilize substantial have resulted in a tax revenue loss of $17 billion an- amounts of tax revenue by taxing private wealth held nually for this group of countries. This exceeds the abroad through capital flight. One of the motives of average annual inflows in FDI and is about 81% of capital flight is to avoid taxation on wealth including annual official development aid inflows over the past that which may have been acquired illegally. While four decades." there are no precise measures of the amount of tax revenue that could be mobilized through taxation of The evidence presented above has clear implications private capital held abroad by residents of developing for thinking about official development assistance as countries, estimates based on statistics on capital a means of helping developing countries reach and flight and illicit financial flows suggest that the gains sustain high growth rates and accelerate their progress in tax revenue are substantial. Using conservative towards their social development goals. The debate assumptions about the rates of return to the assets on assistance to developing countries needs to move accumulated through capital flight (about 7%) and beyond increasing budgetary allocations to foreign by applying a modest tax rate (20%) FitzGerald de- aid to consider ways to help developing countries rives estimates of forgone tax revenue due to capital mobilize more domestic resources. Scaling up inter- flight from developing countries (FitzGerald, 2013). national cooperation and technical assistance in the Using data up to 2006, he finds that developing area of taxation can go a long way in complementing countries as a group were losing tax revenue in the traditional development aid. In fact, international tax order of $200 billion per year, representing 2.5% of cooperation can help countries graduate from official total GDP of this group of countries (FitzGerald, development assistance. This is especially the case for 2013). Considering the case of sub-Saharan African natural resource-rich developing countries that can substantially increase their tax revenue if they can 7 See the PricewaterhouseCoopers 2008 independent rec- manage to effectively tax MNCs operating in these onciliation report for a detailed analysis of discrepancies in the tax reported by the mining companies relative to tax authority's records. PWC (2011). Zambia Extractive In- 9 The published version is Ndikumana and Boyce (2011b). dustries Transparency Initiative: Independent Reconciliation 10 In Table 4, in calculating cumulative amounts of inflows, Reportfor Year End December 2008. (February 2011). the data are matched with availability of capital flight series 8 See Ndikumana (2013) for more discussion on tax revenue annually. So, for every country in any given year, the values implications of private sector corruption in African coun- of ODA and FDI am discarded when capital fight is miss- tries. ing. EFTA00317190 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION Table 4 Illicit financial flows from African countries (Billions of dollars), 2010 prices Cumulative flows over Indicator 1970-2010 Annual average Stock of capital flight 1685.2 Cumulative flows of capital flight 1273.8 31.1 Trade misinvoicing: Export misinvoicing 859.2 21.0 Import misinvoicing -550.1 -13.4 Net misinvoicing 309.2 7.5 Other flows: ODA 874.8 21.3 FDI 459.1 11.2 Debt stock: value 2010 267 Estimated tax loss° 17.2 Sources: Capital flight data are from the Political Economy Research Institute's database (www.peri.umass.edu/300). Note: a The estimated losses are extrapolated from the methodology proposed by FitzGerald (2013), which is based on explicit assumptions about the share of the stock of capital flight that belongs to residents of African countries (assumed equal to 50%), the returns on these assets (7%), and a tax rate of 20% on the taxable income. FitzGerald used capital flight from sub-Saharan Africa as of 2004. The values in this table are obtained by scaling up FitzGerald's results using the proportion of the 2010 cumulative capital flight relative to the 2004 value. Notes: SSA sub-Saharan Africa; MENA Middle East and North Africa: LAC Latin America and Caribbean. sectors, negotiate a fairer share in natural resource institutional reforms in developing countries, the rents, stem capital flight, and collect tax on private donor community can better help these countries assets stashed abroad by their residents. As resource reap the benefits of globalization or at least minimize rich countries are able to mobilize more tax revenue its negative effects. and keep their wealth onshore, then international development assistance would be reallocated to the poorer countries that need it the most (FitzGerald, Ig Taxation and global 2013). The donor community can help these coun- public goods tries in two ways: one is to support and effectively implement measures aimed at preventing tax evasion Globalization opens up opportunities for mobilizing and related illicit practices by MNCs operating in efforts behind initiatives that could generate bene- developing countries; second is to provide technical fits for the larger community as a whole, or global assistance to developing countries in the design and public goods. These include peace and political sta- implementation of reforms of tax systems as well as bility, protection and improvement of the natural the monitoring and prosecution of financial crimes, environment, preservation of food security, eradica- including through establishment and strengthening tion of hunger and poverty, the fight against health of specialized institutions such as national financial pandemics and communicable diseases, and others. intelligence units. Generally, by accelerating global Globalization is accompanied by new challenges that efforts to fight against tax evasion and other forms affect the stability of the global economic system and of financial crimes, and by supporting domestic the environment, and phenomena whose negative EFTA00317191 COP BACKGROUND PAPER NO. 24 consequences cannot be contained within the bor- these innovative taxation tools could go a long way ders of the source country. These are referred to as in financing major global initiatives such as climate 'global public bads and they include climate change, change adaptation and mitigation, the fight against the deterioration of the ecosystem, high-impact com- HIV/AIDS, malaria, tuberculosis and others. At the municable diseases, systemic attacks on global peace same time these tools can help stem instability in the such as terrorism, and global financial instability. At- financial markets. tending to these challenges requires the mobilization of massive financial resources that cannot be met While there are large potential gains from taxation solely by increasing national budgetary allocations aimed at financing global public goods and con- to development aid. Therefore, new and innovative trolling global public bads, the implementation of financing mechanisms need to be explored. such tools faces substantial challenges at both tech- nical and political levels. The biggest challenge is to Coordinated efforts at the global level can leverage build consensus and support from individual gov- innovative taxation as a means both to finance the ernments and institutions around these innovative production of global public goods and to contain or taxation instruments. One reason is that it is difficult discipline the production or spread of global public to quantify and apportion the benefits accruing to bads. In fact, one may even ask why governments each member country. There is, therefore, a risk that only tax goods and do not tax, and even subsidize individual countries may resist taking the initiative public bads such as pollution. One of the ways to to avoid the first-mover disadvantage associated with finance global public goods could be to tax public the free rider problem. Moreover, global initiatives to bads. Thus taxation would generate a 'double divi- mobilize additional tax revenue and to use taxation dends(Griffith-Jones, 2010; Spahn, 2010). It would as a disciplining instrument against global public enable greater production ofpublic goods, while also bads is constrained by the lack of a global institution containing the production and expansion of public entrusted with coordination and execution of such bads. Examples ofsuch taxation include the financial initiatives. Today, there is no such thing as a global transaction tax proposed initially proposed by John taxation authority akin to the global institutions re- Maynard Keyes and aimed at containing financial sponsible for financing issues (e.g., the IMF, the Basel instability arising from speculative financial transac- tions (Keynes, 1936). In the same spirit James Tobin Committee), or trade regulation (e.g., WTO), etc. So proposed in 1974 the introduction of an internation- far, proposals for a supranational authority in charge al currency transactions tax also aimed at taming of global taxation have not made any headway. A global currency markets (Tobin, 1978). While these more feasible avenue would be to work with exist- taxes were initially proposed as stabilization tools, ing institutions and capitalize on experiences at the they actually can generate substantial tax revenue regional level in policy coordination. In this sense, given the massive volume of transactions that take the European Union can offer a fertile ground for place on a daily basis globally. Some estimates sug- implementation. Indeed there is already a substantial gest that even a tinny levy of 0.005% on the trans- degree of coordination of VAT among EU members action of major currencies could raise more than 20 which could offer some lessons for the way forward11 billion euros (Griffith-Jones, 2010; Spahn, 2010). Such experiences could be emulated in other regions By expanding taxation to a larger set of financial and eventually scaled up at the global level. transactions, much more revenue could be raised. Taking 2008 as a base, it is estimated that moder- 11 See Censer (2003); extensive studies and reports are availa- ble online at the European Union's "Taxation and Custom ate taxation on all major financial assets traded in Union" website: brrp•Dec europasuftaxarion,__custom./ the US could generate up to $353 billion annually common/publications/services papers/working papers/ (D. Baker et al., 2009). Revenues generated through index en.htm EFTA00317192 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION ['conclusion through improved tax cooperation and increased transparency have produced limited and uneven re- The discussion in this paper has identified a number of challenges arising from the implications of glo- sults. It is clear, though, that what is lacking is not balization for taxation that face both developed and conventions and agreements. What is lacking is ef- developing countries. These challenges derive from fective implementation and enforcement of existing the increased mobility of capital and the ease ofshift- frameworks; and this is where efforts should be con- ing profits and savings across territories as corpora- centrated going forward. In this context, a few areas tions and individuals take advantage of disparities are worth highlighting. The first is in the area of in institutional and regulatory environments as well exchange ofinformation, which is critical to disman- as the lack of transparency in international transac- tling the tradition of secrecy. In addition to efforts to tions. These developments put a burden on national establish and enforce TIEAs, countries should push tax systems that must strike a balance in meeting the for institutionalization of automatic exchange of in- dual objective of mobilizing government revenue on formation on taxation or AEITs. Second, countries the one hand, and facilitating trade, retaining and and international institutions must swiftly endorse attracting investment capital and savings on the oth- and enforce mechanisms to increase accountability er hand. The proliferation of tax havens, safe havens, and transparency in the corporate sector, especially secrecy jurisdictions, and offshore financial centres with regard to large MNCs. In this regard, the global has made matters even more complicated. community must rally behind efforts to institution- alize rules on country by country reporting as well Even as countries continue to make efforts to adapt as unitary taxation of MNCs so that all countries are their taxation systems to the complex and changing able to duly and systematically collect taxes on all global environment, it is important to maintain a re- activities taking place on their territories and on all alistic and dynamic perspective. As Bird (2012, p. 5) activities undertaken by all their tax payers regard- puts it, there is no magical fiscal system, and there- less of their geographical location. fore "what this complex and changing world needs is not some non-existent 'universal fix' but rather a sort The implementation of the existing conventions, of fiscal medicine kit containing a variety of remedies agreements and frameworks on fighting tax evasion, and treatments that may help us cope with the wide corruption and other illicit financial activities re- variety of fiscal problems and needs that arise at dif- quires substantial technical capacity. Such capacity ferent times and often in different ways in different is generally in short supply in developing countries. developing countries." In this regard, policy-orient- Those countries typically have a thin stock of exper- ed research has an important role to play in shedding tise, or what Kaldor (1963, p. 414) called "a corps light on possible avenues for reforms and expected of capable and honest administrators", which makes outcomes. Thus far, research has tended to be a step it difficult for them to deal with issues of transfer behind and, in fact, it is contended that "research pricing, thin capitalization, and other practices that has not led the reform elephant but mopped behind facilitate tax evasion and profit shifting. Therefore, it" in the sense that it has come to only rationalize the debate on international tax cooperation must reforms and innovations that are already occurring include strategies for assisting developing countries in the real world rather than coming up with novel to build their technical and administrative capacity ideas of reforms (Bird, 2012, p. 14). This is a serious to combat tax evasion and associated illicit financial challenge to the policy research community. practices in the corporate and financial sectors. This should be at the core of the post-2015 development The existing initiatives at the national, regional strategy. and global level geared toward fighting tax evasion EFTA00317193 CDP BACKGROUND PAPER NO. 24 References provision UNU WIDER WorkingPaperNo. 2013/136. Helsinki: Finland: UNU/WIDER. AfDB and GFI. (2013). Illicit Financial Flows and the Fjeldstad, O.-H., Schulz-Herzenberg , C. and Sjursen, H. Problem of Net Resource Transfers from Africa: I. (2012). Peoples' views of taxation in Africa: The- 1980-2009. Washington, DC and Tunis. ories, evidence and an agenda for future research." Andersen, J., Johannesen, N., Lassen, D. D. and E., P. ICTD Working Paper. Bergen, Norway: CHR (2012). Petro rents and hidden wealth: Evidence from Michelsen Institute. bank deposits in tax havens. 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EFTA00317195 CDP BACKGROUND PAPER NO. 24 Appendix Tables Table A.1 Taxes on personal income as percentage of GDP in OECD countries, 1965-2010 Country 1965 1975 1985 1990 2000 2007 2010 Australia 7.1 11.1 12.6 12.0 11.5 10.9 9.9 Austria 6.8 7.9 9.4 8.3 9.5 9.4 9.5 Belgium 6.4 12.9 15.8 13.4 14.0 12.1 12.2 Canada 5.8 10.5 11.5 14.7 13.1 12.3 10.8 Chile Czech Republic 4.4 4.2 3.6 Denmark 12.7 21.4 23.4 24.8 25.6 25.3 24.3 Estonia 6.8 5.8 5.4 Finland 10.1 14.1 14.9 15.2 14.5 13.0 12.6 France 3.6 3.8 4.9 4.5 8.0 7.5 7.3 Germany 8.2 10.3 10.3 9.6 9.5 9.1 8.8 Greece 1.2 1.7 3.6 3.7 5.0 4.9 4.4 Hungary 7.3 7.4 6.5 Iceland 5.1 6.0 5.5 8.3 12.9 13.8 12.9 Ireland 4.2 7.2 10.7 10.5 9.4 8.8 7.5 Israel 10.7 8.1 6.3 Italy 2.8 3.8 9.0 9.9 10.4 11.1 11.7 Japan 3.9 4.9 6.6 7.9 5.6 5.6 5.1 Korea 1.3 2.2 3.9 3.3 4.4 3.6 Luxembourg 6.9 9.0 10.1 8.4 7.2 7.1 7.8 Mexico Netherlands 9.1 11.0 8.2 10.6 6.0 7.7 8.6 New Zealand 9.4 15.4 18.7 17.7 14.3 14.6 11.9 Norway 11.7 12.4 9.6 10.7 10.3 9.5 10.1 Poland 4.4 5.2 4.5 Portugal 4.3 5.5 5.5 5.6 Slovak Republic 3.4 2.6 2.3 Slovenia 5.6 5.5 5.7 Spain 2.1 2.7 5.4 7.1 6.4 7.5 7.0 Sweden 16.2 19.0 18.4 20.1 17.1 14.6 12.7 Switzerland 5.8 9.3 9.9 8.2 8.7 8.8 9.1 Turkey 2.6 3.9 3.2 4.0 5.4 4.1 3.7 United Kingdom 10.1 14.0 9.6 10.4 10.7 10.8 10.0 United States 7.8 8.9 9.7 10.1 12.3 10.6 8.1 Unweighted average OECD 6.9 9.3 10.1 10.3 9.3 9.0 8.4 Source; OECD Centre for Tax Policy Administration (online data on Tax Policy Statistics). Note: 1 From 1991 the figures relate to the united Germany. EFTA00317196 INTERNATIONAL TAX COOPERATION AND IMPLICATIONS OF GLOBALIZATION 25 Table A.2 Taxes on corporate income as percentage of GDP, 1965-2010 Country 1965 1975 1985 1990 2000 2007 2010 Australia 3.4 3.1 2.6 4.0 6.1 6.9 4.8 Austria 1.8 1.6 1.4 1.4 2.0 2.4 1.9 Belgium 1.9 2.7 2.2 2.0 3.2 3.5 2.7 Canada 3.8 4.3 2.7 2.5 4.4 3.5 3.3 Chile Czech Republic 3.4 4.7 3.4 Denmark 1.4 1.2 2.2 1.7 3.3 3.8 2.7 Estonia 0.9 1.6 1.4 Finland 2.5 1.7 1.4 2.0 5.9 3.9 2.6 France 1.8 1.8 1.9 2.2 3.1 3.0 2.1 Germany 2.5 1.5 2.2 1.7 1.8 2.2 1.5 Greece 0.3 0.7 0.7 1.5 4.2 2.6 2.4 Hungary 2.2 2.8 1.2 Iceland 0.5 0.8 0.9 0.9 1.2 2.5 1.0 Ireland 2.3 1.4 1.1 1.6 3.7 3.4 2.5 Israel 3.9 4.5 2.9 Italy 1.8 1.6 3.1 3.8 2.9 3.8 2.8 Japan 4.0 4.2 5.6 6.4 3.7 4.8 3.2 Korea 1.3 1.8 2.5 3.2 4.0 3.5 Luxembourg 3.1 5.1 7.0 5.6 7.0 5.3 5.7 Mexico Netherlands 2.6 3.1 3.0 3.2 4.0 3.2 2.2 New Zealand 4.9 3.3 2.6 2.4 4.1 4.9 3.8 Norway 1.1 1.1 7.3 3.7 8.9 11.0 10.1 Poland 2.4 2.8 2.0 Portugal 2.1 3.7 3.6 2.8 Slovak Republic 2.6 3.0 2.5 Slovenia 1.2 3.2 1.9 Spain 1.4 1.3 1.4 2.9 3.1 4.7 1.8 Sweden 2.0 1.8 1.7 1.6 3.9 3.7 3.5 Switzerland 1.3 2.0 1.7 1.8 2.6 3.0 2.9 Turkey 0.5 0.6 1.1 1.0 1.8 1.6 1.9 United Kingdom 1.3 2.2 4.7 3.5 3.5 3.4 3.1 United States 4.0 2.9 1.9 2.4 2.6 3.0 2.7 Unweighted average OECD 2.2 2.1 2.6 2.6 3.4 3.8 2.9 Source; OECD Centre for Tax Policy Administration (online data on Tax Policy Statistics). Note; 1 From 1991 the figures relate to the united Germany. EFTA00317197