The Need for an International Solution to Illicit Financial Flows

by Rohit Sinha

This summer, the UN High-Level Panel’s Report on the Post-Millennium Development Goal Agenda called on countries to work together to reduce illicit financial flows (IFFs) and tax evasion and increase stolen asset recovery. The international community would do well to heed the Report’s recommendations. Global Financial Integrity, a Washington, D.C.-based research and advocacy organization, estimates that developing countries lose nearly USD 1 trillion in IFFs—including everything from corruption to tax evasion—every year. This sobering statistic reflects a boom in fraudulent activity by global actors and an international financial structure ill-equipped to stop them. Cooperation among countries to bolster regulation of transnational financial flows, as the Report proposes, is essential to curbing IFFs.

Existing efforts to tackle IFFs are narrowly focused on curbing domestic money laundering and tax evasion. The recent Foreign Account Tax Compliance Act passed by the U.S. Congress, which seeks to recover the estimated$150 billion lost to the U.S. government annually in tax haven abuses, is a case in point. While small-scale domestic initiatives are a start, an increasingly global problem calls for a global solution. Both developing and developed countries should move beyond narrow initiatives curbing discrete problems like tax evasion and collaborate on a more multifaceted and integrated set of solutions to tackle IFFs.

Current International Response to IFFs

Various United Nations instruments already exist to combat IFFs. For example, the UN Convention Against Corruption (UNCAC) is the first legally binding international anti-corruption instrument and has 168 parties. Its provisions focus on international cooperation, asset recovery, technical assistance, and information exchange between countries. However, the dearth of technical cooperation between developed and developing countries has hindered the effective enactment and enforcement of these provisions.

IFFs are also firmly on the agenda of the G20 forum. One of the core objectives of the G20 forum is to limit global imbalances in financial flows, including the possibility of regulatory arbitrage. In response to a proposal by the Organization for Economic Cooperation and Development (OECD) for a global model for the automatic exchange of information, G20 leaders announced in September 2013 that they expected “to begin to exchange information automatically on tax matters among G20 members by the end of 2015” and urged all countries to join the Convention on Mutual Administrative Assistance on Tax Matters “without further delay.”

Additionally, the G20 has mandated that the Financial Action Task Force (FATF), an intergovernmental body that issues standards and recommendations pertaining to threats to the international financial system, as well as identifying and monitoring high-risk jurisdictions. However, without a comprehensive model to estimate IFFs, this task will be difficult as it is often hard to tell the difference between licit and illicit financial flows. The recent revelation that Apple had been shielding billions of dollars from taxation by declaring that three subsidiary companies had “no tax residency” in Cork, Ireland, where they were incorporated, is a case in point.

Going Forward

These international efforts are important, but tend to mirror domestic efforts that are narrowly focused and difficult to enforce. More comprehensive initiatives are needed to truly make an impact. Developed countries should hold their financial institutions to higher standards of corporate governance and promote greater accountability and transparency in their services. They should also provide greater technical assistance to developing countries. Developing countries  should strengthen their economies and institutions and implement the rule of law. It is also essential that they remain active in efforts to curb IFFs, as the loss of approximately $1 trillion dollars from developing countries to IFFs is almost thirteen timesthe amount that EU member states spent on development aid in 2012.

These reforms require massive structural overhauls and should occur gradually.  In the meantime, groups like the G20 and G8 should continue to lead coordinated efforts for automatic cross-border exchange of tax information, disclosure of beneficial ownership information for all companies, greater enforcement of and penalties for trade mispricing, and exploitative transfer pricing and money laundering. These initiatives can serve as models for the broader international community. Additionally, multinational corporations throughout the world should be required to publish information on their sales, profits, taxes paid, and number of employees on a country-by-country basis. Finally, countries should require financial institutions to identify the ultimate “beneficial” owner of all accounts held in, or passing through, their jurisdictions.

The UN High-Level Panel Report calls for a more effective and robust global partnership between countries to tackle development challenges.  Given the transnational impacts of IFFs, this type of partnership is needed more than ever.

Views expressed in this piece are solely the author’s.

About the Author

Rohit Sinha is a Research Scholar at the Centre for Economy & Development at the Observer Research Foundation, an independent public policy think-tank based in New Delhi, India. His research focus has been primarily international trade and investment, including the impact of trade agreements in the South Asia region. Previously, he served as a policy analyst in the office of a Member of Indian Parliament.

The Case for Treating Migration as Trade

An Interview with Fletcher School Dean James G. Stavridis