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ISSN 1688-1672



Illuminating the dark corners of the financial system*

Marina Ponti and Federica Biondi
The elimination of tax evasion has never been high on the political agenda of governments, but the fight against criminal organizations and illegal trade has. Despite this difference in terms of priorities, the events of the 11th of September show that the attempt to use international financial mechanisms, to freeze the financial assets of those suspected of being involved in the terrorist network, was not completely successful due to the current structure of the financial system

"The fundamental problem is to find a social system which is efficient economically and morally".
J.M.Keynes 1925

While donor countries continue to neglect their commitment to the 0.7% for official development assistance, lamenting lack of resources, these same countries allow the many dark corners of their financial markets to cause large and increasing losses of fiscal revenues every year.
Financial markets are not transparent; this implies an enormous loss of revenue and creates a breeding ground for illicit transactions. The current international financial system disperses those precious resources, which could otherwise be used for the implementation of successful development policies. Unfortunately this issue has been neglected by the Monterrey Conference on "Financing for Development", despite its relevance in the pursuit of development.

Transparency of financial markets means a correct management of all information related to capital flows. The benefits of transparency are many, but most importantly, full tax revenue. Greater public resources would be available for the pursuit of public policies, amongst these development and a greater redistribution of wealth. Although developing countries have often been reprimanded for their insufficient and malfunctioning financial and tax systems, where the loss of potential tax revenue decreases their ability to guarantee social services and defend human rights, they are not the only guilty parties in the game. Northern countries hold a great responsibility by allowing vicious mechanisms to contaminate financial markets, both on a national and international scale, leading to a general loss of revenue..

On a European level, there are many examples of tax systems which allow funds deriving from commercial activities in one country to flow through a special agent company in their country, before being transferred to a company registered in tax haven. Various countries in Europe allow agent companies to operate in their territory.

The workings are the following. The agent company (A), situated in one of these particular European countries, is both the mother company of the active company (C)
(situated in a different country) and the daughter of a company H situated in a tax haven. Given that the agent company acts on behalf of H, providing only financial services (i.e the collection and distribution of the proceeds of the commercial company C), said agent company is only allowed to retain a small percentage of the profits created by C and destined to H. This mechanism thus allows all the proceeds of C to flow through A and reach H. H then "pays" A for its services and this amount is then taxed in the country where A is situated. But the amount paid to A by H for its services is a very small percentage of the total sum of funds which it channels.

The implications are various: the commercial company C evades taxation in its country, thus drastically reducing the tax revenue for said country; the intermediate country
(i.e that of company A) receives a tax revenue which it would otherwise not receive, given that company A's sole purpose is that of "providing services" for H (i.e channeling the funds); the large majority of revenue produced by C ends up in a tax haven where no (or a minimal) taxation is applied. These operations not only distort the fiscal framework, but also lead to negative fiscal effects in the country of origin, which, seeing its tax revenue reduced, seeks other ways of increasing it, by increasing the tax pressure. This causes general discontent amongst the tax-paying population, thus further increasing the risk of funds fleeing the country illegally to avoid such high taxation. A vicious circle sets in.

Another example of the lack of transparency in cross-border financial transactions is that of agencies which transfer money worldwide, using money orders. These entities have a highly widespread network of offices all over the world. They are used mainly by people who have moved from a "developing country" to a "developed" one to find work, and wish to send part of their earnings to their family, without the complications of opening a bank account. Considering the number of people which find themselves in such a situation, it is easy to deduce that the figures involved are huge, and most importantly, not monitored. Not even the traditional banking system has a clear idea of its size. It ensues that neither do the fiscal authorities.

A third point: bank secrecy toward governmental authorities, including tax authorities, may enable tax payers to hide illegal activities and to escape tax. The effective administration and enforcement of many laws and regulations, including those on taxation, require access to, and analysis of, records of financial transactions. Technological advances, particularly in the area of e-commerce and banking, have made international banking readily accessible to a wide range of taxpayers, not just the large multinationals and the wealthy individuals. The elimination of exchange controls by OECD countries and many non-member countries, also has facilitated the rapid expansion of cross-border financial transactions. This new era of "banking without borders" has raised new challenges for tax administrations around the globe.

Experience has shown over the last fifty years that inadequate access to bank information has been an impediment to tax administration and law enforcement. The scope of non-compliance with the tax laws, that is facilitated by lack of access to bank information, is difficult to measure precisely because there is insufficient access to the necessary information.

The same problem exists in attempting to measure the extent of money laundering. Nevertheless FATF (Financial Action Task Force on Money Laundering annual report 1995-96) estimates that the size of that problem amounts to hundreds of billions of dollars annually.

The elimination of tax evasion has never been high on the political agenda of governments, but the fight against criminal organizations and illegal trade has. Despite this difference in terms of priorities, the events of the 11th of September show that the attempt to use international financial mechanisms, to freeze the financial assets of those suspected of being involved in the terrorist network, was not completely successful due to the current structure of the financial system. Despite the political primacy of the case, it was not possible to obtain all the information from banks and other actors involved.. This means that financial mechanisms, as they stand today, are not able to counteract illegal transactions when necessary. Greater transparency and stricter rules should be prioritized by richer countries, not only as a means of fostering social justice and redistribution of wealth, but also as an instrument to fight criminal operations and terrorism.

In this sense, tax cooperation becomes crucial to address all of the above. However, the political will to put tax cooperation in place is not yet there. The current international framework shows the exact contrary, with the proliferation of tax havens (40 countries at present). Tax havens represent the total absence of financial transparency and impede any form of fiscal cooperation. Tax havens offer many services with very high added value, whose cost is paid by those who do not use the services. Financial mechanisms which involve tax havens can be used for the discrete management of huge family fortunes, as well as of the revenues of show-business or sports people; for speculation and fiscal fraud; for fiscal evasion and the transfer of multinational profits to their off-shore shell companies; to finance political parties and men; to pay all kinds of illicit operations.

Tax havens offer a wide range of relatively low-cost financial services: bank secrecy protected above any juridical request; absence of exchange controls; the right to stipulate any kind of contracts, to carry out any transaction and set up any company, even if fictitious, guaranteeing anonymity; absence of fiscal pressure; free access in real time to all the worldwide markets; guaranteed connection with the largest bank circuits, usually represented on location; weak or non-existent mechanisms for the repression of financial criminality. Furthermore, their mere existence encourages people to use them.

The first draft of the preparatory document in view of the Monterrey Conference "Financing for Development", prepared by the former President of Mexico Zedillo, contained a very important proposal regarding the setting up of a tax organization. This would have mainly been in charge of addressing tax matters, the tax-harmonization process, the fight against tax havens and, more broadly, tax competition.
Moreover, such an organization could have been the right forum for discussion on the implementation of global taxes, devoted to financing the Millennium Development Targets contained in the Millennium Declaration, as agreed upon by Heads of States and Governments in September 2000.
Along these lines, a currency transaction tax could be a relevant step forward and a concrete proposal for monitoring cross-border financial transactions. Moreover, the setting up of a similar tax system would necessarily require the transparency of financial flows.

Currently, most financial transactions are carried out through the SWIFT banking system. Therefore, through the SWIFT itself, such a tax could be implemented and enforced.
In addition, as an increasing number of civil society organizations argue, a currency transaction tax would:
reduce short-term speculative currency and capital flows;
enhance national policy autonomy; restore taxation capacity of individual countries eroded by the globalization of markets; distribute tax pressure more equitably among different sectors of the economy; trace movements of capitals to fight tax evasion and money laundering.

Transparency will be achieved when the political will to put it in place becomes reality. Civil society will continue to fight for its achievement, despite the current lack of such a political will. Transparency means democracy, and democracy is a vital component of human development.

"There is nothing more difficult to execute, nor more dubious of success, nor more dangerous to administer, than to introduce a new order of things; for he who introduces it has all those who profit from the old order as his enemies, and he has only lukewarm allies in all those who might profit from the new. This lukewarmness partly stems from fear of their adversaries…and partly from the skepticism of men, who do not truly believe in new things unless they have actually had personal experience of them".
Macchiavelli, The Prince, 1532.

*Published in Social Watch





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