Locating tax risk – the way to tackle illicit financial flows

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These are the slides for the talk I presented in Beirut this afternoon:

Locating tax risk - the way to tackle illicit financial flows

1 There are illicit financial flows

  • This is a fact
  • It’s also true we will never stop them entirely
  • This means everything we say today is about risk mitigation

2 The questions we need to address

  • What are the risks?
  • How do they arise?
  • What can actually be done about them?
  • Why is it worth tackling them?
  • Why is it worth expending political capital on this?
  • What are the tools we need to use?

3 What is tax for?

  • It is assumed that pays for government expenditure.
  • This is at best only partly true
  • Government spending can also be funded by:
    • Borrowing
    • Aid
    • Local currency creation
  • So while may have an important role in the funding cycle of government that is not its only use

4 Tax has other uses:

  • Creating macroeconomic control of an economy
  • This is through fiscal macroeconomic management
  • Underpinning the value of the local currency by requiring its use to settle tax liabilities
  • Income and wealth redistribution
  • Repricing market failure
  • Incentivising socially beneficial activities

5 The Joy of Tax

  • Put all these facts together and you have what I call The Joy of Tax
  • Tax is the single most powerful peaceful instrument a government has to shape the society that it controls
  • The challenge of illicit financial flows is that they undermine any government’s chance of achieving that goal
  • The big challenge of illicit financial flows is not then the money alone - however important that is
  • The big challenge of illicit financial flows is that they challenge the ability of the state to deliver a whole range of policy options that it wants to create on behalf of those who live in the jurisdiction for which a government is responsible

6 How to tackle this?

  • The choice to date has been to blame some now familiar villains
    • Organised crime
    • Those who are corrupt
    • Multinational corporations
    • Tax havens
  • The response is
    • Anti-money laundering measures
    • OECD BEPS
    • Country-by-country reporting
    • Calls for unitary taxation
  • Trust me, I buy them all
  • But the time has come to go further

7 We need new tools to identify and tackle tax abuse

  • There are two key new tools:

1.Measuring tax gaps

2.Undertake tax spillover assessments

  • These require political will
  • And they require funding - if necessary from the IOs to help achieve this – which is something I am explicitly calling for

8 The tax gap (1)

  • The tax gap is a measure of the tax that could be but is not collected by a government
  • All countries have a theoretical tax yield they could collect based on current GDP and law
  • They don’t get it because of the tax gap, which comes in five parts

1 The cost of tax bases not taxed, such as wealth (A)

2 The cost of tax allowances and reliefs a government grants (B)

  • Take these two off the theoretical tax base calculated on GDP and you get the technical tax yield. Then deduct

3 Tax evasion (C)

4 Tax avoidance (D)

5 Tax bad debt (E)

  • And you get to tax actually paid

9 The tax gap (2)

  • The tax policy gap is
  • Tax bases not taxed + tax reliefs given away
  • = A + B
  • The tax compliance gap is
  • Tax evasion + tax avoidance + tax evasion
  • = C + D + E
  • The total tax gap is:
  • Theoretical tax base based on GDP
  • Take away A + B + C + D + E
  • = Tax actually paid
  • Every government had to know these figures, I suggest, or they’re not in control of their economy

10 Tax spillovers

  • Tax spillovers assess the likelihood that one part of a tax system causes harm to another part of a tax system, either domestically or internationally
  • Tax spillovers happen domestically and internationally
  • They involve all taxes, but especially direct ones
  • And they involve the administration of tax as well as the taxes themselves
  • The IMF has tried to appraise them quantitatively but this has proved to be very hard
  • Professor Andrew Baker of Sheffield University and I now propose a qualitative measure

11 Qualitative tax spillovers - the assessment grid

12 Qualitative tax spillovers - the process

  • Four domestic taxes and four tax admin systems are marked for the risk that they create domestically first and internationally second
  • Then the domestic tax system is appraised for the risks imposed on it from elsewhere
  • The higher the score the bigger the risk
  • The colour coding simply helps identify the big risks – they are in red
  • The process is designed to identify the biggest targets for reform

13 Qualitative tax spillovers –our suggestion

  • It’s our suggestion every country could and should do a qualitative tax spillover assessment
  • Then they will know what reform is really needed
  • And how effective it might really be
  • This is the way for all countries – and not just OECD ones – to reclaim the agenda on this issue
  • We think it’s time to use a systematic tool for each country to create its own demands for reform