April 24, 2016
Politicians, Bankers and Illicit Cash
by Dr. KS Jomo*
Unlike earlier Wikileaks’ exposes, the recent Panama Papers revelations were quite selective, targeted, edited and carefully managed. Most observers attribute this to the political agendas of its mainly American funders.
Nevertheless, the revelations have highlighted some problems associated with illicit financial flows, as well as tax evasion and avoidance, including the role of enabling governments, legislation, legal and accounting firms as well as shell companies.
The political tremors generated by the edited release of 11 million documents were swift. Nobody expected Iceland’s Prime Minister to resign in less than 48 hours, nor the British Prime Minister to publicly admit that he benefited from the hidden wealth earned from an opaque offshore company of his late father.
How low can you go?
In the 1960s, there was a popular dance called the ‘limbo rock’, with the winner leaning back as much as possible to get under the bar. Many of today’s financial centres are involved in a similar game to attract customers by offering low tax rates and banking secrecy. This has, in turn, forced many governments to lower direct taxes not only on income, but also on wealth.
From the early 1980s, this was dignified by US President Ronald Reagan’s embrace of Professor Arthur Laffer’s curve which claimed higher savings, investments and growth with less taxes.
With the decline of government revenue from direct taxes, especially income tax, many governments were forced to cut spending, often by reducing public services, raising user-fees and privatising state-owned enterprises. Beyond a point, there was little room left for further cuts. Hence, governments had to raise revenue, typically from indirect taxes. These were mainly on consumption, as trade taxes were discouraged to promote trade liberalisation.
Many countries have since adopted value-added taxation (VAT), long promoted in recent decades by the International Monetary Fund (IMF) and others as the superior form of taxation: after all, once the system is in place, raising rates is relatively easy.
Malaysia not progressive
A progressive tax system would seek to ensure that those with more ability to do so would pay proportionately more tax than those with less ability to do so. Instead, tax systems have become increasingly regressive, with the growing middle class bearing the main burden of taxes.
Meanwhile, tax competition among countries has not only reduced tax revenue, but also made direct taxation less progressive, while the growth of value-added tax (VAT) has made the overall impact of taxation more regressive as the rich pay proportionately less tax with all the loopholes available to them, both nationally and abroad.
Although there are many reasons for income inequality, hidden untaxed wealth has undoubtedly also increased wealth and income inequality at the national and international level.
As my late colleague, Professor Ismail Muhd Salleh showed, overall tax incidence in Malaysia has long been regressive, but has also become more regressive over time. Later work by Professor Wee Chong Hui confirmed that income inequality is not only worse after taxes, but has also become worse, especially since the mid-1980s.
Recent public resistance to the goods and services tax (GST) suggests that many have a gut feeling that all is not well, let alone fair.
Illegal capital outflows
According to Global Financial Integrity (GFI), Malaysia lost US$418.542 billion during 2004-2013, losing US$48.25 billion in 2013 alone.
The illegal capital outflows stem from tax evasion, crime, corruption and other illicit activities. Malaysia is fifth, among the top five countries for illegal capital flight, after China, Russia, Mexico and India, but tops the list, by far, on a per capita basis.
GFI’s December 2015 report found that developing and emerging economies had lost US$7.8 trillion in illicit financial flows over the decade, with illicit outflows increasing by an average of 6.5 percent yearly.
Over the decade, an average of 83.4 percent of illicit financial outﬂows were due to fraudulent trade mis-invoicing, involving intentional misreporting by transnational companies of the value, quantity or composition of goods on customs declaration forms and invoices, usually for tax evasion.
Following the Panama revelations, most Western government leaders have pledged tougher action against tax evasion and avoidance, especially by those using developing country havens. In the face of declining aid flows to poor countries, the OECD’s Development Assistance Committee (DAC) chair, Erik Solheim, has suggested greater tax efforts instead.
But since they receive most of the funds in the tax havens in the world, the OECD has historically focused on very limited matters. Hence, these same governments have blocked efforts to give the United Nations (UN) a stronger mandate to advance international cooperation on taxation, culminating in the modest Addis Ababa Action Agenda declared at the third UN Financing for Development conference in July last year.
As major users of such facilities, many developing country leaders have been conspicuously silent in the face of recent revelations of what they have long enabled and practiced. After all, much of what is involved is publicly considered illicit, immoral, even ‘sinful’, even if it is not illegal. Very often, the rich currently pay less in taxes than most of their lowest paid employees.
But what is shocking in Malaysia is the blatant defence, even advocacy of tax avoidance, by leaders of a government which has been running major budgetary deficits for two decades. While the Malaysian public is being burdened with GST, incredibly, ministers are insisting that tax avoidance is fine.
Rather than blame the political opposition, scurrilous rumour-mongers or critical social media for the lack of public trust in the authorities, those concerned may wish to look in their mirrors first.
Dr. JOMO KS was United Nations Assistant Secretary-General for Economic Development, and received the Wassily Leontief Prize for Advancing the Frontiers of Economic Thought in 2007.