Stemming Illicit Financial Outflows Jomo Kwame Sundaram

International capital flows are now more than 60 times the value of trade flows. The Bank of International Settlements (BIS) is now of the view that large international financial transactions do not facilitate trade, and that excessive financial ‘elasticity’ has been a major cause of recent financial crises.

Illicit financial outflows 

Illicit financial flows involve financial movements from one country to another, especially when funds are illegally earned, transferred, and/or utilized. Some examples include:

  • A cartel using trade-based money laundering techniques to mix legal money, say from the sale of used cars, with illegal money, e.g., from drug sales;
  • An importer using trade mis-invoicing to evade customs duties, VAT, or income taxes;
  • A corrupt public official or family members using an anonymous shell company to transfer dirty money to bank accounts elsewhere;
  • An illegal trafficker carrying cash across the border and depositing it in a foreign bank; or
  • A terrorist financier wiring money to an operative abroad.

Global Financial Integrity (GFI) estimates that in 2013, US$1.1 trillion left developing countries in illicit financial outflows. Its methodology is considered to be quite conservative, as it does not pick up movements of bulk cash, mispricing of services, or most money laundering.

Beyond the direct economic impact of such massive haemorrhage, illicit financial flows hurt government revenues and society at large. They also facilitate transnational organized crime, foster corruption, undermine governance and decrease tax revenues.

Where does the money flow to?

Most illicit financial outflows from developing countries ultimately end up in banks in countries like the US and the UK, as well as in tax havens like Switzerland, the Cayman Islands or Singapore. GFI estimates that about 45 per cent of illicit flows end up in offshore financial centres and 55 per cent in developed countries. University of California, Berkeley Professor Gabriel Zucman has estimated that 6 to 8 per cent of global wealth is offshore, mostly not reported to tax authorities.

According to GFI, Malaysia lost US$418.542 billion during 2004-2013, losing US$48.25 billion in 2013 alone. The illicit capital outflows stem from tax evasion, crime, corruption and other illicit activities. Malaysia is fifth among the top five countries for illicit capital flight, after China, Russia, Mexico and India, but tops the list, by far, on a per capita basis.

GFI’s December 2015 report found that developing and emerging economies had lost US$7.8 trillion in illicit financial flows over the preceding ten-year period, with illicit outflows increasing by an average of 6.5 per cent yearly. Over the decade, an average of 83.4 per cent of illicit financial outflows were due to fraudulent trade mis-invoicing, involving intentional misreporting by transnational companies of the value, quantity or composition of goods on customs declaration forms and invoices, usually for tax evasion.

Stemming the haemorrhage

Many tax avoidance schemes are not illegal. But just because it is not illegal does not mean it is not a form of abuse, fraud or corruption. To tackle the corruption at the heart of the global financial system, tax havens need to be shut down, not reformed. ‘On-shoring’ such funds, without prohibiting legitimate investments abroad, will ensure that future investment income will be subject to tax as in the US and Canada.

If not compromised by influential interests benefiting from such flows, responsible governments should seek to enact policies to:

  • Detect and deter cross-border tax evasion;
  • Improve transparency of transnational corporations;
  • Curtail trade mis-invoicing;
  • Strengthen anti-money laundering laws and enforcement; and
  • Eliminate anonymous shell companies.

(This article was originally published in Inter Press service (IPS) news on March 1, 2017)