by Jason Hickel
Trade misinvoicing, for its part, involves sending money into secret offshore accounts by cheating the trade system. For example, imagine that a South African firm has agreed to buy $1 million of steel from a British firm. The South African firm requests that the British firm send the invoice for $1 million to a tax haven. The tax haven then reinvoices the South African firm at more than the agreed value of the goods – say $1.5 million. The South African firm pays the $1.5 million to the tax haven. The tax haven then pays $1 million to the British firm and diverts the rest to an offshore account. As far as the tax authorities in South Africa can tell, the transaction appears legitimate – but the South African firm has successfully spirited $500,000 into an offshore account where it will never be taxed. Tax havens openly advertise their reinvoicing services and offer to assist firms in setting up shell companies to launder money and evade taxes. A quick Google search for ‘re-invoicing services’ turns up dozens of companies located in the Seychelles, Mauritius and so on, ready and willing to help companies secret their money offshore. In 2013, trade misinvoicing accounted for 80.6 per cent of illicit outflows from developing countries, or $879 billion.
Trade misinvoicing is usually used for tax evasion. But it can also serve many other purposes. Sometimes it’s used to launder money from criminal activities or to dodge capital controls that countries have put in place to stabilise financial flows. Firms might also use trade misinvoicing to inflate their exports in order to qualify for special tax incentives that governments offer to exporters. But even when the goal is not necessarily tax evasion, the effect is the same, for all forms of trade misinvoicing deny governments the opportunity to tax income and wealth.
The researchers at Global Financial Integrity can detect reinvoicing because of the obvious differences between the invoices reported by exporters and importers for the same customs transaction. But this is the only form of trade misinvoicing that they are able to detect. There are other forms of misinvoicing that go completely under the radar, such as ‘transfer mispricing’.
To understand how transfer mispricing works, we first have to understand normal transfer pricing. Transfer pricing happens when companies sell goods within their own corporate structure, for example if a subsidiary in China sells goods to another subsidiary in Britain. Because of the rapid expansion of corporate monopolies over the past few decades, today at least 60 per cent of world trade takes place within multinational corporations, rather than between them. So transfer pricing is not an exceptional practice – it is the norm. And under normal circumstances it is completely legal, as long as subsidiaries report the correct market prices of the goods in question as if they were conducting trade with an outside entity, ‘at arm’s length’. But quite often companies artificially distort transfer prices in order to evade taxes or dodge capital controls; this is when transfer pricing becomes transfer mispricing.
Transfer mispricing is remarkably easy. All a company has to do is write out an invoice that falsely reports the cost of an item, and then get their trade partner to write out a similarly false invoice on the other side – in other words, ‘same-invoice faking’. Analysts have recorded some flagrant examples of this: a kilogram of toilet paper from China priced at $4,121, a litre of apple juice from Israel priced at $2,052, ballpoint pens from Trinidad priced at $8,500 each. By inflating transfer prices, a company can magically move its money from subsidiaries in high-tax countries to subsidiaries in low-tax countries – often in tax havens. Because this practice is so difficult to detect, no one knows the full scale of the problem. Global Financial Integrity estimates that it probably amounts to outflows that are at least equivalent to the scale of reinvoicing. That means another $879 billion flowing out of developing countries each year. And it may even be more than reinvoicing, given that transfer mispricing is so much easier to get away with.
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The biggest loser in this game is Africa. Already the world’s poorest region, sub-Saharan Africa suffers total illicit outflows that amount to 6.1 per cent of its GDP. In fact, Africa loses so much through illicit flows that it is effectively a net creditor to the rest of the world. If we tally up all types of legal and illegal financial flows, including investment, remittances, debt forgiveness and natural resource exports, we see that Africa sends more money to the rest of the world than it receives. The provocative graph below illustrates the sheer scale of the capital that is dripping out of Africa’s open veins.
Source: Global Financial Integrity
In total, developing countries may have lost as much as $2 trillion in 2013 through hot money and trade mispricing, or a mind-boggling $14.3 trillion over the past decade. And in case these numbers aren’t staggering enough, keep in mind that the misinvoicing figures only reflect trade in goods, not trade in services. GFI is not able to capture misinvoicing for services. We have no idea what the scale of illicit flows might look like in the service sector, but since trade in services counts for 25 per cent of global trade, we can probably bump the figures up by the same proportion.
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Who is to blame for this state of affairs? Companies that lie on their invoices are guilty of illegal activity, but why is it so easy for them to get away with it? Terms like ‘capital flight’ and ‘illicit outflows’ seem to find fault with the victim countries, as though they’re just unable to catch the money. But this is misleading. In the past, customs officials in developing countries had the power to prevent misinvoicing. If the prices reported on an invoice diverged suspiciously from the normal market prices of the goods in question – as listed by the Brussels Definition of Value – they could hold up the transaction. This made it virtually impossible for corporations to get away with theft through trade. But the WTO argued that this made trade inefficient. Since at least 1994, customs officials have been required to accept invoiced prices at face value, barring exceptional circumstances. As a result, corporations have free rein to write out their invoices however they please, with little risk of being called out. This is why mispricing has grown at such a rapid rate since the mid-1990s.
Still, none of this theft would be possible without the tax havens. Altogether, there are around fifty to sixty tax havens in the world. They function as tax havens not only because they offer low or zero tax rates, but because they have very little financial regulation and, most importantly, they shroud financial information behind a veil of secrecy. Indeed, the technical term for a tax haven is secrecy jurisdiction. In most cases, banks and corporations operating out of secrecy jurisdictions are not required to disclose anything about where money comes from and where it goes – and in some cases it is actually illegal to disclose such information. Given this, secrecy jurisdictions afford robust protections not just for tax evaders but for all kinds of criminals – including money launderers, arms smugglers and even terrorists.
It is impossible to know how much money is stashed in the world’s tax havens, but a lowball estimate in 2010 suggested the figure was at least $21 trillion, and probably closer to $32 trillion – about $9 trillion of which is from poor countries. The money stashed away in tax havens amounts to more than one-sixth of all the world’s private wealth. Today, at least 30 per cent of all foreign direct investment flows through tax havens, and about 50 per cent of all trade.
There are three main categories of tax havens. There are tax havens in Europe, like Luxembourg, Switzerland and the Netherlands, which are probably the best known, as well as Belgium, Austria, Monaco and Lichtenstein. Then there are the tax havens in the United States, such as Manhattan, Florida and Delaware, as well as US-linked territories like the Virgin Islands, the Marshall Islands, Liberia and Panama. But by far the biggest and most powerful network of tax havens is organised around Britain – and was crafted by the once powerful British empire. There are the three British Crown dependencies of Jersey, Guernsey and the Isle of Man. Then there are the fourteen British Overseas Territories, which include the Cayman Islands, the British Virgin Islands and Gibraltar. Finally, there are a
number of territories that Britain no longer formally controls, but which used to be under its imperial power: Hong Kong, Singapore, the Bahamas, Dubai, Ireland, Vanuatu and Ghana.
Probably the most important central node in this global tax haven system is the City of London. While it may seem confusing, the City of London is not the same thing as London itself. It is a small council within London that houses London’s powerful financial sector. The City of London is able to function as a tax haven because it is immune from many of the nation’s laws, is free of all parliamentary oversight and – most importantly – is exempt from Freedom of Information rules. It even has its own private police force. As a result of this special status, the City has maintained a number of quaint plutocratic traditions dating back to medieval times, when it was founded. Take its electoral process, for instance. Unlike in normal councils, the franchise in the City of London is not restricted to human beings. Businesses registered within the council’s borders are allowed to vote alongside residents. More than 70 per cent of the votes cast during council elections are cast not by humans, but by businesses – mostly corporate banks and financial firms. And the bigger the corporation, the more votes they get, with the largest firms getting seventy-nine votes each. The City even has its own mayor – the Lord Mayor of London, not the better-known Mayor of London – who respects the authority of no one but the monarchy. The Lord Mayor is ‘elected’ each year by a group of corporations and his sole role (it has been a man every year since 1189) is to promote the interests of the City’s banks.
According to the website of the City of London, the Lord Mayor’s job is to ‘open doors at the highest levels’ for business and ‘expound the values of liberalisation’. To do this, he has at his disposal a multibillion-pound slush fund for use in lobbying the UK government and governments around the world to bring in laws that are friendly to banks and multinational companies. He’s like a one-man structural adjustment team. On top of this, part of the Lord Mayor’s mission is to travel abroad in order to build the City’s tax haven network. The last incumbent spent 100 days abroad in a single year, and visited more than twenty countries. At the time of writing, the new Lord Mayor was lobbying hard to turn Kenya into a tax haven.
The problem with tax havens is not only that they facilitate the theft of capital, or that they prevent governments from capturing revenues, but also that they induce what analysts call ‘tax competition’ or ‘tax warfare’. Tax havens have set off a kind of global race to the bottom, with countries competing to offer low tax rates to foreign investors in order to attract them in. This constant pressure to reduce taxes makes it very difficult for parliaments and governments to make rational decisions about tax legislation, or to plan their budgets into the future.
Some economists nonetheless believe that the global tax haven system is justifiable according to neoliberal theory: they claim that money should be allowed to move freely around the world in search of the best tax rates. But much about the tax haven system runs directly against the principles of free markets. For example, trade mispricing makes a mockery of the idea of ‘market prices’: the prices of many of the goods that get shipped around the world have nothing to do with the market at all – they are simply invented out of thin air. The tax haven system also violates the principles of comparative advantage. For one, it provides the equivalent of an unfair subsidy for companies that are rich enough to take advantage of tax evasion services. But more importantly, it means that companies move around the world not to where they can be most efficient, but to where they can find the greatest secrecy or the lowest taxes. The fact that the tiny British Virgin Islands hosts some 850,000 companies (for a population of 25,000) makes the idea of comparative advantage seem quaint.
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In light of all this, the question of corruption begins to take on a somewhat different hue. Given the role of Britain, the United States and various European countries in facilitating illicit flows by building and maintaining the global tax haven system, and in light of the role that the WTO plays in making it difficult for customs officials to clamp down on mispricing, it seems a bit strange that rich countries appear in corruption-free yellow on the Transparency International map.
One of the problems with TI’s methodology is that it measures people’s perceptions of corruption, rather than corruption itself. People who live in Britain may not normally think of their country as being particularly corrupt, but that may be because corruption is something that they have been taught to associate with countries in the developing world – not with the rich world. In this sense, Transparency International might be helping to create the very perceptions that it seeks to measure.
Corruption in developing countries is cited as a major cause of underdevelopment – and for good reason. But it is important that we expand our conception of corruption to include illicit outflows, anonymous companies, secrecy jurisdictions and so on in order to understand how serious the problem of corruption actually is. Inasmuch as these practices siphon resources out of the global South, they contribute significantly to global poverty and inequality, and yet the mainstream definition of corruption does not encompass them, and they are absent from the UN Convention. Instead, the corruption narrative diverts our attention away from these exogenous problems and places the burden of blame on developing countries themselves.
The Land-Grabbers
In early 2007, something unexpected happened. Reports began to trickle out about rising food prices around the world, and then suddenly, within a matter of weeks, it was a full-blown crisis. Seeing their survival on the line, people took to the streets across much of the global South. In Burkina Faso, food prices soared by 65 per cent, triggering protests and riots in many of the country’s major cities. In Cameroon, protests turned violent and led to the deaths of twenty-four people. In Bangladesh, tens of thousands of workers marched in the capital. Mexico, Morocco, Mauritania, Senegal, Côte d’Ivoire and many other countries were hit with similar unrest. In Egypt, the food-price crisis galvanised the mass social discontent that would eventually topple the dictatorship of Hosni Mubarak. By 2008, the IMF had announced that world food prices had increased by 80 per cent in a single year. In a world where more than half the population lives below the poverty line, such an increase in the price of food meant potential starvation for hundreds of millions of people.
For casual Western observers, it was easy to dismiss this crisis as a natural phenomenon – the inevitable result of fluctuating supply and demand in the market. And certainly there was some of this at play. Rising incomes in China were translating into higher demands for meat and milk, and as a result, huge swathes of the world’s agricultural fields were being retooled to feed livestock instead of people. In the United States, demand for biofuels meant that one-third of the nation’s corn crop was being channelled into ethanol production, with many farmers planting fewer food crops in order to cash in on the biofuel craze. At the same time, climate change had caused droughts in a number of key grain-producing countries, reducing their export volumes; global harvests continued to grow, but not as quickly as before. The rising price of oil – which hit historic highs during this period – might also have had something to do with it, driving up the costs of farming inputs and food transportation. But none of these drivers were significant enough to account for the sheer scale of what was going on.
Beginning in 1991, Goldman Sachs took advantage of new financial deregulations and decided to bundle commodity futures – including food – into a single index. Traders could then speculate on this index and investment funds could link their portfolios to it. It was a new kind of financial derivative, one of many such instruments that were being peddled on Wall Street in those years. For the most part, investors didn’t pay it much mind, and the index remained something of a financial backwater for many years. But as the first hints of the sub-prime mortgage crisis began to appear in 2005, nervous investors pulled out of mortgage derivatives and pumped their money instead into commo
dities, which are supposed to be stable even when the rest of the economy falters. The result was rampant speculation on commodity futures, which affected prices in the real economy. This had a particularly dramatic impact on food prices, which skyrocketed and hit record highs in 2007. In other words, people who were savvy enough to pull out of the housing bubble before it burst ended up inflating another bubble – this time in food.
The crisis didn’t stop there. World food prices continued to fluctuate wildly, crashing in 2009 back to pre-crisis levels, and then surging again in 2010 to break yet new records. In 2011, prices were 2.5 times higher than they were in 2004 – a trend aggravated by climate-change-induced weather events that were affecting yields in grain-producing regions of Russia and North America. According to UN sources, in 2011 some 40 million extra people around the world had been plunged into serious hunger.
As if the food-price crisis wasn’t bad enough for the world’s poor in and of itself, it had a dramatic knock-on effect that no one saw coming. Investors seized the opportunity to buy up millions of acres of land around the world for agricultural production – for both food and biofuels – in order to take advantage of the soaring prices. Many governments got in on the game as well, worried about future social unrest and anxious to secure stable food supplies in a world threatened by climate change. Countries not self-sufficient in food were particularly eager to snatch up farmlands, especially given that a number of big food-producing countries were cutting down on exports in order to ensure they had enough for their own needs.