The EU, in common with other major economies of the world, loses a significant amount of potential tax revenue every year to tax evasion and tax avoidance. Some EU-wide estimates are as high as 500 billion – 1,000 billion Euros annually.
This tax loss takes two major forms 1) domestic and international. Domestic tax losses come about when the taxable funds are not shipped overseas but stay within the country. This form of tax loss is on the decline as the increasingly electronic nature of financial transactions and an economy that is less and less cash oriented make domestic avoidance harder.
At the same time, tax flight, the loss of tax revenues related to cross border flows of funds, has been rising rapidly.
Changes to the international economy, such as 1) growing cross-border trade and financial flows 2) increasing complexity of MNC operations and international production networks 3) the liberalization of capital and current accounts and 4) the growth of jurisdictions such as ‘tax havens’ which legislate to help economic actors avoid regulatory and tax obligations in other jurisdictions, have significantly increased the opportunities for economic actors to legally and illegally reduce their tax payments.
The internationalisation of economic activity has not been accompanied by the internationalization of tax governance or even significant progress on cross-border co-operation on tax matters. This has allowed economic actors to use international economic linkages to escape paying taxes – a phenomenon called tax flight. This tax flight severely weakens domestic resource mobilization in the European Union and also damages the social contract and undermines good governance. That is why, it must be tackled urgently.
Tax flight takes place most frequently through the unrecorded or mis-reported cross-border transfer of resources, also known as capital flight. Tax flight can either be the driving force behind capital flight or a by-product of it. However, the tax reduction motive is by far the biggest driver of capital flight. The main motivations for engaging in capital flight belong to two categories – the push factors and the pull factors.
The main push factors are 1) the economic actor does not want to pay taxes on otherwise legitimate wealth 2) the wealth was acquired illegitimately so there is a risk of confiscation 3) the actor is trying to circumvent other domestic legislation such as financial regulations.
The main pull factors often are provided by ‘tax havens’ mostly as the combination of 1) zero or low taxation and/or lax regulation which are both financially lucrative 2) anonymity provided through bank secrecy, shell companies & offshore trusts which minimises the risk of detection 3) and a lack of co-operation on tax matters with source country authorities which minimises the risk of prosecution.
As the high profile cases of secret Liechtenstein trusts uncovered by Germany, Swiss banks raided by Germany, Italy and France and secret Swiss accounts investigated by the United States indicate, EU and other developed countries lose large sums of money to tax flight. Cumulative tax flight from developed countries has been variously estimated to be in the range of $5 - $10 trillion.
Such tax and wealth leakage, undermines the welfare state, exacerbates austerity, increases social tensions and drives higher inequality. Tackling tax flight has to be the top EU tax priority given that hospitals and welfare are bearing the brunt of austerity measures. There is excessive focus on reducing expenditure and too little focus on increasing revenue. Because such a large part of the world economy is facing the same problem, the single minded focus on expenditure reduction risks pushing the world into another recession.
What needs to be done?
Tax flight can only happen under a suitable confluence of conditions at the source, transit and destination points and in a suitable international environment. That is why it can be mitigated by actions at one or more of these points. By changing the risk to reward ratio – increasing risk (the likelihood of getting caught and/or severity of consequences) and reducing reward (the economic benefits) capital flight and associated tax flight can be substantially reduced. Some of the main policy areas for action are:
At the source
Even before the crisis hit with full force, several countries in and outside the EU had already been taking some unilateral steps to reduce tax flight. The measures being taken by various countries have multiplied since the crisis has broken out and the full range of direct and indirect costs have become clear putting several countries under severe fiscal stress.
Some of these policy measures were spectacularly successful while others were complete duds. Much can be learnt from both sets of measures in terms of what other countries should and should not do. Some examples of these successful measures are
· adopting a financial transaction tax (which generated information that helped substantially reduce domestic and cross-border tax evasion in Brazil) which increases the risk of detection
· adopting special reporting requirements and fewer exemptions for investments and financial flows to and from ‘tax havens’ (Argentina and Spain) (reducing rewards and increasing risks)
· requiring accounting firms to register tax shelters before selling them (USA and UK) (increasing risks)
· initiating a cross-departmental program of the kind that exists in Australia (Project Wickenby – which is a task force that comprises the tax office, crime commission, security and investment commission and a number of other relevant governmental bodies) to tackle tax flight (increasing risks)
· aiming for legal rulings (as done in the UK and Ireland) which would require banks to report customers with undeclared offshore bank accounts (increasing risks)
· introducing rewards for data on offshore bank accounts (as used by Germany)
· using legal means to extract data on offshore bank accounts of residents (Italy, Germany and France) etc
These and a host of other successful policy measures can be replicated widely either unilaterally at member state level or in a co-ordinated fashion by the EU.
Tax flight cannot take place without the active facilitation of intermediaries both at the source and destination. Professionals such as accountants, lawyers and bankers usually structure tax flight through transactions in a way that minimises risks of detection and maximises rewards. So targeting them can significantly increase the risks for those engaging in tax flight. Some measures are 1) Ensuring that tax crimes committed in foreign jurisdictions are a reportable offence 2) Targeting intermediaries to report suspected tax flight transactions at the risk of prosecution 3) Including tax flight in the AML and UNCAC regime will make it obligatory for intermediaries to report tax flight 4) Introducing professional codes of conduct for professionals which include not facilitating tax flight. 5) Ensuring that new financial regulations and obligations for financial institutions being introduced in the aftermath of the crisis now are compatible with tax information sharing and meeting tax reporting obligations.
At the destination
· Making the recording of beneficial ownership information by financial centres including ‘tax havens’ obligatory. This would need to include bank accounts, trusts, foundations, companies and all other legal vehicles. Maintaining public registers on such real ownership interests so relevant authorities can access them would seriously reduce anonymity and the benefits it offers.
· Moving towards a better sharing of information on the ownership of financial flows/assets associated with bank accounts, investments, companies, foundations & trusts registered in these territories significantly increases the risks of detection & prosecution. The Tax Exchange Information Agreements being currently negotiated and the mutual legal assistance instruments are often not good enough tools for an effective exchange and sharing of information. A multilateral agreement on effective exchange of information would be an effective tool. Even in the absence of a genuinely multilateral agreement, an agreement for the EC to negotiate tax treaties on behalf of member states would significantly improve the bargaining power of Member States vis a via Tax Havens.
Since tax flight arises mostly due to a co-ordination failure at the international level the best way to tackle it is also at the international level. Some of the policy measures that can change the present risk-reward to help reduce tax flight are listed below
The adoption of a country by country accounting standard would be a very effective tool in tackling tax flight 2) The extension of existing OECD and EU information sharing agreements to other G-20 countries 3) Restructuring and upgrading the UN Committee on Tax Experts and increasing its resources and authority 4) Setting up a UN trust fund to finance alternative development paths for small island ‘tax havens’ which help tackle tax flight 5) Redefining the AML regime to include tax flight as a reportable offence 6) Reinterpreting the UNCAC to include tax flight as corruption 7) Extending the remit of the Stolen Asset Recovery (STAR) initiative to include fled capital associated with tax evasion 8) Building automatic exchange of information into the UN and OECD tax treaties, tax information exchange agreements and working on a multilateral effective exchange of information regime 9) Constructing a policy map for successful unilateral policies which can be replicated 10) Introducing the fair payment of taxation into all discussions of CSR and Include a fair payment of taxes into the OECD guidelines for MNCs and the EU code on business taxation 11) Adopting a UN code of conduct on co-operation in combating tax flight 13) Giving Tax flight a higher public profile including through governments producing estimates of losses to tax flight.
While the rhetoric of the G-20 on tackling tax havens was strong at the outset, the issue has slipped off the G-20 agenda without much significant progress having been made and it would be essential for the EU to put the issue back onto the agenda of the forthcoming French G-20 meeting.