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Accounting for poverty How international tax rules keep people poor Contents Foreword Executive summary 1. What better tax rules could do 2. S  tealing from the poor 3. Taxing across borders 4. The great tax giveaway 5. Tax authorities: a worthwhile investment 6. A rich man’s club: why all countries need to be involved 7. Recommendations 2 4 10 18 30 36 44 46 48 Susan Agondeze, at Katasenywa primary school, Masindi, Uganda. Globally, 18 million new teachers are needed by 2015 to meet the goal of universal primary education – with more tax revenue, governments could pay for all of them. PHOTO: Georgie Scott/ActionAid 1 Foreword The new UK government policy was subsequently enshrined in its International Development White Paper, which acknowledged both that “tax systems in developing countries are undermined by international banking secrecy, including in tax havens,” and that “ineffective taxation Until this point, few would have undermines countries’ ability to predicted the summit’s ensuing provide the basic services that commitment to, “developing proposals, underpin fairness as well as growth.” by end 2009, to make it easier for This shift in government policy was in developing countries to secure the part the result of nearly a decade’s benefits of a new cooperative tax environment,” a process which, at the campaigning and research, by academics, activists and charities in time of writing, is still ongoing. the Tax Justice Network. The centre of gravity of the current ActionAid started doing research into global political debate rests with the this issue in early 2008 and started G20 and OECD, both groups of some of the world’s richer countries. Many campaigning on tax shortly before the But the London Summit represented breakthrough of 2009 occurred. Our small states have been branded ‘nonanother important milestone. It was staff and partners in developing compliant’ and told that they must the first time that the governments of meet an international standard of countries led the way to this area of the major economies – following the work. They believe that developing information exchange. These states lead taken by the UK – acknowledged countries should themselves be able to have the option of doing the the impact of international tax rules finance more of the services that are minimum possible to meet this on developing countries. This began standard, but alternatively they could essential to tackling poverty, through with British Prime Minister Gordon tax revenue. The problem is that choose to become an important part Brown’s promise in advance of the much of this revenue is lost through of the solution by championing the summit that, need for real, improved transparency. tax avoidance and evasion, given away The first half of 2009 brought with it an extraordinary and unexpected burst of activity concerning international tax matters. Tax havens found themselves in the eye of a proverbial perfect storm. A new US president with a track record of seeking to “stop tax haven abuse”; an unprecedented banking crisis with some of its roots in offshore finance; a global recession and a Keynesian response to it that meant governments needed to eke out every last pound of tax revenue; high-profile examples of tax evasion uncovered in Liechtenstein and Switzerland – all seemed to coalesce around the sequence of G20 meetings and in particular the London Summit in April 2009. 2 “we will set out new measures to crack down on the tax havens that siphon off money from developing countries – money that could otherwise be spent on bednets, vaccinations, economic development and jobs.” in tax concessions to multinational companies, or not raised in the first place because of deficits in tax policy and administration. This paper sets out some of the steps that ActionAid believes need to be taken, at global and national level, so that developing country governments can effectively fund poverty reduction efforts in a way that reinforces their sovereignty and accountability to their citizens. It builds on the work of our colleagues in the Tax Justice Network and elsewhere, and underpins ActionAid’s work in the UK and globally to achieve tax justice for the poor in developing countries. As we publish this report, there are more opportunities than ever before to make such progress: it is up to the leaders of rich and poor countries alike to seize them. Nurun Nahar Begum, at Naora government primary school, Shahrasti, Chandpur, Bangladesh. The school has 400 students, but only nine teachers. Bangladesh’s government wants to reduce the pupil-teacher ratio, but needs more tax revenue to do it. PHOTO: GMB Akash/Panos Pictures 3 Executive summary Keeping poor people poor Governments in developing countries need to spend more money on essential public services if they are to have a serious impact on poverty. Take the United Nations Millennium Development Goals (MDGs), a set of targets for halving extreme poverty, providing universal primary education, halting the spread of HIV and AIDS and much more by 2015. Ambitious, yes, but achievable. To meet many of the MDGs, governments will need to hire more public sector employees, from teachers and doctors to agricultural extension workers. For example, it is estimated that 18 million new teachers will be needed between 2004 and 2015 to achieve universal primary education. As for healthcare, the World Health Organization (WHO) estimates that there is a global shortage of 4.3 million health workers. In 2010, governments will need US$178 billion (£96 billion) in external assistance to get on track to meet the MDGs, yet in 2008 they received US$120 billion (£65 billion) – leaving a US$58 billion (£32 billion) shortfall. Since then, a number of countries including Italy, France and Ireland have reduced their aid commitments. Meanwhile, the financial crisis and recession have reduced the chances of meeting the MDGs yet further. For example, ActionAid has calculated that African economies will suffer a real drop in income of US$49 billion (£27 billion) between the start of the financial crisis in 2007 and the end of 2009. As a result, governments will be left with less money to spend on fighting poverty. Predicted tax revenues have fallen by 6.8% in India in a year. African countries as a whole are expected to go from a budget surplus of 1.8% of GDP in 2008 to a deficit of 5.1% in 2009. Unless this gap is filled, many people will continue to live in poverty. 4 “One of the most pressing issues facing our continent is to embark on a path to free African countries from their dependence on foreign assistance and indebtedness. An indispensable condition of this is the strengthening of our capacity to mobilise domestic resources.” African Tax Administrators’ Forum, Pretoria, 2008 “Pay your taxes and set your country free.” Kenya Revenue Authority slogan “Taxation is key to increasing our legitimacy and ability to make our own decisions.” Mary Baine, Commissioner General, Rwanda Revenue Service, 2009 What better tax rules could do Stealing from the poor Low-income countries – and most middleincome countries too – raise a much smaller proportion of their national income in taxes than rich countries. The average for low-income countries as a whole is just less than 15% of national income, but many raise a much smaller proportion; in contrast, the world’s richest countries raise on average 37%. The globalisation of financial flows has created many new opportunities for companies and individuals to evade taxes in developing countries, undermining the revenue base desperately needed for development. Although it will be a long time before developing countries can match their richer counterparts in terms of tax revenue, experience shows that with adequate political will and external assistance, a lot can be achieved within a few years: • Rwanda quadrupled the amount of tax it raised between 1998 and 2006 • Uganda raised its tax-to-GDP ratio from 7.2% to 12.6% in just over a decade • South Africa now raises 29% of its GDP in tax, compared to 24% in 2001 ActionAid has calculated that, if all developing countries were able to raise just 15% of their national income as tax revenue – a commonly accepted minimum figure – they could realise at least an additional US$198 billion (£99 billion) per year. This amount is more than all foreign development assistance combined, and enough to meet and exceed the annual MDG funding gap. Many multinational groups of companies are complex structures with hundreds of subsidiaries, a substantial number of which may be located in tax havens. Profits are allocated between subsidiaries through internal trading, a complicated process that is hard for tax authorities to police. It allows for profits to be allocated to subsidiaries in tax havens, reducing a group’s overall tax liability. The Guardian calculated in 2007 that the world’s three biggest banana companies paid on average 14% tax on their profits, despite all three having their head offices in the US, where the corporate tax rate is 35%. 8%: the amount of Bangladesh’s national income raised in tax; 37%: the amount of the UK’s national income raised in tax Some companies further take advantage of the system through transfer mispricing, manipulating the prices at which internal trading takes place. Global Financial Integrity (GFI), a research institute based in Washington, DC, has estimated the amount of money that leaves developing countries as a result of transfer mispricing. For 2006, it put the figure at between US$471 billion and US$506 billion (£262 billion and £275 billion). 5 US$160 billion (£89 billion): the estimated annual cost to developing country governments of tax evasion by multinational companies 6 Christian Aid estimates that developing countries collectively lose US$160 billion (£89 billion) in tax revenues as a result of transfer mispricing and other international tax evasion by multinational companies. This is only one aspect of international tax evasion: in total, the South African Revenue Service estimates that it loses up to R64 billion (£4.7 billion) each year in revenue because of tax evasion in tax havens. The Tax Justice Network estimated that governments across the globe lose $255 billion (£140 billion) annually in tax revenues from high net worth individuals, based on the likely income earned on some $11.5 tillion (£6.3 trillion) of assets held offshore. Recommendation: a county-bycountry financial reporting standard Spotting potential cases of transfer pricing abuse is made harder than it might otherwise be by international financial reporting standards (IFRS), which only require multinational groups of companies to report on a consolidated basis – that means one set of accounts showing the overall financial activities and results for the group, without breaking them down for each country. Introducing a countryby-country reporting standard into IFRS would help civil society, the media and tax authorities to uncover potential cases of tax avoidance and evasion. The Organisation for Economic Cooperation and Development (OECD) has been asked to study the feasibility of a country-by-country reporting standard. It should report back to the G20 and United Nations during 2010, and these bodies should formally request that the International Accounting Standards Board, which sets IFRS, adopts it. Recommendation: better tax information exchange Tax authorities in developing countries need to be able to gather information from their counterparts in other countries, so that they can build up a picture of a company’s profit-making activities and financial transfers – or indeed an individual’s income generation – across the globe. At present, even if they have an information-sharing agreement with another state, tax authorities have no automatic right to this information – ie currently they must demonstrate that the information they are requesting is ‘foreseeably relevant’ to their administrative or enforcement work, and provide a prohibitively large amount of information to prove this. Ongoing discussions at the G20 and OECD should result in a fully global, multilateral tax information exchange agreement, which lays the foundation for an eventual automatic tax information exchange system. It should incorporate multilateral countermeasures for noncompliance and, if they request it, support for developing countries to develop their technical capacity so that they can adhere. A robust review mechanism will be essential to evaluate benefit to developing countries. Taxing across borders When a company’s supply chain – or an individual’s income-generating activities – spans several countries, which government should benefit from the tax revenues they owe? Countries tackle this question differently, and many – including developing countries – have signed double taxation agreements to clarify the situation. Yet this global system of different treaties and tax rules has created opportunities for businesses and individuals to exploit the system, by arranging their dealings and the way they distribute their income to avoid tax payments. An important example is the channelling of investments through tax havens, to reduce the taxes paid by subsidiaries in developing countries. This is why in 2002 (the most recent year for which data is available), 46% of Foreign Direct Investment (FDI) flowing into Brazil came from tax havens. Similarly, 43% of India’s FDI between April 2000 and March 2009 came from Mauritius. Double taxation agreements (DTAs), which are a necessary part of the picture to prevent the same income being taxed twice, can contribute to such tax avoidance measures. For example, Mauritius – an important source of investment for African countries – has DTAs with a large number of countries, including 10 African states. The DTAs prevent African countries from taxing capital gains made within their borders by Mauritius-based investors, and put a maximum ceiling on the taxes that African countries can apply to dividends earned by Mauritius-based investors. The result: developing countries miss out on tax revenues from multinational investors. Recommendation: stronger taxing rights for developing countries A system of taxation that confers more taxing rights on the country in which income arises, and insists that tax residence be more closely linked to economic activity, would be of more benefit to developing countries. Governments should therefore ensure that double taxation agreements into which they enter strike an optimal balance between raising revenue and attracting investment that benefits poor people. Developing countries should work together to promote and improve the United Nations ‘model double taxation convention’, a double taxation treaty that better takes developing countries’ needs into account, especially through the United Nations Committee of Experts on Tax Matters that developed it. “Aggressive tax avoidance is a serious cancer eating into the fiscal base of many countries.” Pravin Gordham, South African Finance Minister, 2009 “These times call for a tougher attitude from employers, workers and governments. We cannot go on living with tax havens.” Luiz Inacio Lula da Silva, Brazilian President, 2009 “We should endorse sharing information and bringing tax havens and noncooperating jurisdictions under closer scrutiny.” Manmohan Singh, Indian Prime Minister, 2009 7 The great tax giveaway The use of tax incentives to compete for investment has been a cornerstone of development plans for many years. The doctrine of ‘tax competition’ casts countries in the role of competitors in a marketplace for investment, despite the numerous problems with this analogy. Perhaps the most high-profile example is the World Bank and PriceWaterhouseCooper’s annual ‘Doing Business’ indicators, which since 2006 have included a ranking of countries according to an estimate of the ‘total tax rate’ incurred by companies. “Lower tax burdens for businesses lead to more economic activity,” is the philosophy espoused by its creator. The principal long-term incentive offered by developing countries is a reduction in the corporate tax rate. Africa’s low-income countries reduced it from 44% in 1980 to 33% in 2005. Others include tax holidays, typically a reduction in or exemption from profit taxes, royalty fees and/or trade tariffs for the first few years of an investment. A recent IMF survey of sub-Saharan African countries shows a remarkable increase in these tax incentives: in 1980 less than half offered tax holidays; by 2005, more than two thirds did. 8 There is conflicting evidence on the effectiveness of tax incentives. While there is some evidence to suggest that tax rates affect investment decisions, the quality and quantity of the investment that tax incentives attract is questionable. “Foreign investors, the primary target of most tax incentives, base their decision to enter a country on a whole host of factors… of which tax incentives are frequently far from being the most important one,” says an IMF paper from 2001. Tax incentives can cost developing countries dear. In 2008-09, India gave away 11.4% of its entire tax revenue – £8.8 billion – through concessions to businesses. Reductions in mining royalty payments in Zambia cost US$63 million (£35 million) in foregone revenue between 2004-6. Recommendation: tax business fairly It is the responsibility of national governments to design tax systems that will raise enough revenue to finance public investments and redistribute wealth equitably. Governments should aim to strike an optimal balance between raising revenue and attracting investment that benefits poor people when setting corporate tax rates and offering tax incentives, and refrain from granting tax incentives unless there is a well established evidence base to demonstrate the benefit for poor people of similar incentives. In particular, governments should undertake tax expenditure analyses that show the extent of tax incentives as part of the budgetary process; they should refrain from fixed-term tax holidays and from granting discretionary tax exemptions to individual companies. International organisations such as the IMF and World Bank should not encourage countries to put in place tax policies that further the race to the bottom. Companies should not use economic or political power to extract tax incentives from developing country governments. At a minimum, they should comply with the OECD Guideline II (5): “Refrain from seeking or accepting exemptions not contemplated in the statutory or regulatory framework related to environmental, health, safety, labour, taxation, financial incentives, or other issues.” Tax authorities: a worthwhile investment Another reason for low tax revenues in developing countries is that tax administrations are poorly resourced and lacking in staff capacity. In Bangladesh, for example, for resourcing and political reasons the National Board of Revenue has not been able to hire any new qualified tax officials for over 20 years. Though VAT and customs units are supposed to have 7,326 staff, at least half of these are vacant posts. Significant investment of resources, expertise and political will in a tax authority can substantially improve the depth and breadth of a country’s tax base, and improve compliance. With the help of foreign assistance, Rwanda built the autonomy and capacity of its revenue authority, increasing the amount of revenue it collected fourfold in eight years. Yet in 2005, only 1.7% of the US$7.1 billion (£3.9 billion) in bilateral aid committed for public sector administration went to improving tax administration. Recommendation: investing in tax authorities Developing countries should invest time, money and political will in strengthening national tax inspectorates with the aim of substantially increasing the proportion of their national budgets that come from domestic tax revenue, and the overall size of the budget, to meet their international poverty reduction commitments. Richcountry governments and international donors should increase the funding and technical assistance available to developing countries that request it. All countries need to be involved Combating international tax competition, avoidance and evasion in a way that benefits developing countries requires a forum that can create and enforce global rules designed to benefit all. Yet at present there is no global body that possesses the political mandate, legitimacy and technical expertise necessary to do this. Work is proceeding fastest through the G20 and OECD, but both bodies have a big representative problem: they are rich countries’ clubs, even though they may invite developing countries to participate in some initiatives. The United Nations Committee of Tax Experts suffers from a lack of political mandate and resources. US$198 billion (£99 billion): the extra amount governments in developing countries would gain each year if they raised just 15% of their national income in tax Recommendation: more inclusive global cooperation Tax cooperation should ultimately be tackled by a representative political body with a political mandate from all countries. As a first step, all governments should support the United Nations Committee of Experts on Tax Matters by upgrading it to an intergovernmental body, and by promoting its Model Tax Convention and Code of Conduct on Cooperation in Combating International Tax Evasion. Tax is a fundamentally political matter, and all governments need to take responsibility for changing a global system that benefits the rich, at the expense of the poor. 9