Back to search

NORGLOBAL2-Norge - global partner

The Role of Tax Havens: In Global Governance and Regulation; In the External Financial Equation for Economic Development

Awarded: NOK 4.9 mill.

-This project demonstrates the massive scale of resource loss from developing countries and the role of tax havens in facilitating these financial outflows. The project is organized in three parts: an estimation of net resource transfers from developing countries incorporating illicit and unrecorded outflows, an analysis of how tax havens (also referred to as secrecy jurisdictions) affect markets and lead to inefficient outcomes, and a quantitative examination of growing holdings by developing country residents in tax havens. Part I of the project presents a broader approach to development than is typical in most economic studies in that we estimate the effects of both recorded and unrecorded flows on the net resource transfers (NRT) into or out of such countries. Previous studies have typically examined NRT as consisting only of recorded financial flows. This study broadens that scope in two ways. First, we include non-financial transactions (such as debt forgiveness and write-offs) and transfers (such as workers? remittances) among the factors affecting recorded transfers. Second, and most importantly, we include unrecorded capital outflows to estimate the NRT of developing countries. The inclusion of unrecorded financial flows is also consistent with the fact that financial institutions (including those in tax havens) cannot distinguish between recorded (licit) and unrecorded (mostly illicit) capital. Hence, any study that seeks to analyze the role of tax havens in financial intermediation would need to consider both types of flows. The principal finding presented in Part I of the project is that, on balance since the late 1990s, substantial amounts of capital have moved from developing to developed countries. Using the broader definition of NRT introduced here, developing countries have effectively served as net creditors to the rest of the world, an ironic twist to the development narrative. The flow from resource-poor countries to resource-rich countries flies in the face of allocative efficiency calling for flows in the reverse direction. On a global scale, such misallocations of resources represent sizeable social costs that would, in this case, be borne by the citizens of developing countries. A total of over US$16 trillion or about US$500 billion per annum on average flowed out of developing countries (for which we have complete data) over the 33 year period from 1980 to 2012. Because the Chinese economy is so large, we also examine capital flows to and from the developing world excluding China. This adjustment reduces the magnitude of cumulative net transfers from the remaining developing countries to nearly US$12 trillion or about US$350 billion per annum on average. Preliminary results show that both recorded inflows by themselves and such inflows less illicit outflows are significantly correlated with real per capita consumption in those countries as a group. In other words, to the extent that growing illicit outflows drain resources, and therefore reduce the impact of recorded inflows, we can expect real per capita consumption and hence living standards to decline in developing countries. These results need to be corroborated based on more comprehensive Balance of Payments data over a much longer time span. Part II of the project analyzes how tax havens affect markets and lead to inefficient outcomes. Through a survey of externalities that follow from tax haven legislation, such externalities are shown to have a negative impact on non-tax haven states, firms, and citizens. It provides evidence that tax havens undermine national and international regulation and shows that tax havens have a detrimental effect on growth in poor countries. The section examines how tax systems and ?ring-fencing? in tax havens are structured. It describes how these structures promote asymmetric information, which in turn impedes upon market efficiency. As tax havens allow individuals and firms to conceal information about their identities and activities, wrongdoers may not bear the full consequences of their actions. When combined with lax or non-existent regulation and/or supervision, this opacity can facilitate the breach of laws and regulations in other countries as a result of the reduced risk of being caught. Furthermore, through abusive transfer pricing and affiliate lending, multinationals are able to lower taxable income in developing countries, thereby denying these governments an important stream of public revenue from which to invest in infrastructure and social programs. In this way, secrecy jurisdictions contribute to the erosion of institutional quality and democracy in poor countries. The section concludes with an overview of tax information exchange treaties (TIEAs) and their potential ability to curb the detrimental impact of tax havens on other countries. In Part III of the project, we use the stock of assets held in tax havens as a proxy for the extent of financial intermediation.

This project focuses precisely on analysis of the relationships between tax havens, global governance, capital flows, and developing countries. It will comprise two parts. First, it will produce a macro analysis of the impact of tax havens on a range of g overnance issues. Second it will appraise the volume of financial flows between developing countries and tax havens, and similarly appraise the percentage that tax havens account for in the volume of financial flows between developing countries and the re st of the world. Better economic data, the second part of the project, is required in order to address the problem posed by tax havens to major governance issues, the first part of the project, for countries constituting some 80 percent of global populati on. This project is the first seeking to produce highly credible analyses of the sum of financial interactions between developing countries, tax havens, and the world and translate this economic analysis into a careful study of how such flows affect a bro ad array of major global concerns.

Funding scheme:

NORGLOBAL2-Norge - global partner