Now that we are almost into the post Millennium Development Goals (MDGs) era, it would be useful to initiate a dialogue on development programs to be implemented after 2015. Among the MDGs targets is developing a global partnership for development (Goal 8). It wouldn’t be wrong to say that Goal 8 remains one of the toughest and most ambiguous challenges for the nations worldwide. The responsibility here lies not only with the poor and developing nations, but also with the developed nations in helping the former gain a level playing field in the international trade, because the domain of international trade still remains largely out of access for developing nations. Among various issues that remain to be discussed, financial liberalization and its effects on development is a largely unexplored area. In particular, I would like to discuss the magnitude and implications of direct and indirect forms of tax avoidance by Multinational companies (MNCs) on developing nations. [break]
In the latest G8 conference, British Prime Minister David Cameron, frustrated with the nominal taxes paid by Britain’s largest MNCs, launched a passionate plea to regulate the tax structure of countries known as tax havens, so that companies pay taxes in the countries where they make their money. While this agenda has caught the attention of world leaders only recently, the problem has always existed for developing nations. For those resource-rich nations that rely on large foreign companies for extraction and processing of their natural resources, legal tax avoidance has been the norm rather than exception.
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By making use of various global tax laws and loopholes and their monopoly over technology, companies manage to extract their profits without paying any taxes. Now the problem has spread to fast-growing nations with large domestic markets. The lowest estimated losses in revenue due to such avoidance come to US $255 billion, and the cost to the developing nations at around US $60-120 billion (in 2008). One must keep in mind that due to large informal/black economies prevalent in these regions, these numbers are most likely underestimates.
These are substantial losses. Mongolia, for instance, estimated revenue losses from its mining projects to be around US $6 billion, more than 100 percent of GDP. For deficit-running, resource-short nations, this represents a gaping hole for the exchequer, the costs of which must be borne by higher taxes. To put it in context, the official revenue losses from tax avoidance are almost equal to the total official development assistance received by developing nations worldwide. This significant source of income can be utilized for all sorts of development and poverty eradication programs.
Also, corporate taxes by nature are direct taxes. Direct taxes are non-inflationary, and do not impact the level of overall profit in the economy, and therefore are non-determinants of private investment. Resource deficit due to insufficiency and inability to raise or collect direct taxes leads to increase in indirect taxes, which are regressive and stagflationary, leading to higher costs for consumers and lower growth for the economy.
Another important implication of such outflows is the burden they pose on the foreign reserves. For many developing nations, foreign exchange remains an important resource for development. Free flow of untaxed income out of the country depletes foreign currency reserves. If the drain of resources is too large, it can lead to drop in the currency value, which might lead to inflation. Continuous uncontrolled outflow of money is one of the main reasons behind the continuous fall in the value of Indian rupee (and consequently Nepali rupee) vis-à-vis the US dollar in the recent months.
In the meantime, corporations rack up huge profits that just sit as reserves in their balance sheets without being returned either to the shareholders or invested anywhere, primarily to avoid taxes in their home countries. Apple, for instance, has cash reserves worth an astonishing US $145 billion, most of which is accrued outside the US and held in offshore accounts, utilizing which will make it liable to corporate income tax in the US. Companies then sit on vast reserves. Clearly, income taxed and spent on poor nations is better than income in the reserves of companies that refuse to invest even in their home nations.
Regulating the biggest companies in the world with vast political clout and economic resources will not be easy. Recent efforts by Mongolia and Zambia to change the laws to force MNCs to pay up were met with severe rebuke by OECD (Organization for Economic Cooperation and Development). In an era of dominance of the dogma of financial liberalization, laws regarding taxation and control on the movement of finance will be considered economic heresy. But companies, simply said, need to pay their taxes, especially in nations where they operate. Over the years, the share of corporate taxes in total tax income has declined dramatically globally.
Developing nations have been making this case for years, but since developed nations benefited from the loose tax regime, no attention was paid. The situation is different now. Rich nations are going through an era of austerity. They are facing severe resource crunch, and with the emergence of tax havens globally, even developed nations are finding that collecting taxes from corporations is necessary, but also incredibly difficult. A positive in all this is that there is a clear recognition of the problem. Tackling the problem, however, is another story. Even if some action is taken, history suggests that developing nations will not reap much benefit.
The MDGs have been successful in eradicating many aspects of absolute global poverty, but have failed to tackle the various institutional factors that result in inequality of access and opportunities. Equality of resources and opportunities in the global market is one of them. Any rethinking of a development model should incorporate the issues of fair trade not only of the industrial sector, but also the financial sector. Rethinking global tax laws to avoid the flight of finance and profits should definitely be a part of it.
The author is pursuing his Masters in Economics at Jawaharlal Nehru University
shaleen778@hotmail.com
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