Monday, February 5, 2018

Why do DFIs support tax avoidance?

Paddy Carter uses the platform of "liberal" think-tank Centre for Global Development to make an astonishing argument in support of the use of tax havens by development finance institutions (DFIs). Consider the straw man arguments against DFIs investing through tax havens,
The argument rests on the answers to two questions: what do DFIs use tax havens for, and what are the alternatives to using them? The short answers are that tax havens are used to compensate for shortcomings in the legal systems of the countries that DFIs invest in, and that if DFIs stopped using tax havens, they would use onshore financial centres in rich countries instead. And that would not help developing countries one jot.
The two questions are the right ones but the answers to both are wrong. 

DFIs use tax havens because they go along with the preferences of their commercial co-investors and their investees, all of whom strongly prefer to invest through offshore financial centres (OFCs). I can understand the need for a holding company incorporated in a third country without the "shortcomings in the legal systems of the countries that DFIs invest in". But let's face it, the preference of commercial investors for that company to be incorporated specifically in an OFC comes from two directions - the tax benefits and the cover of opacity. The case for tax avoidance is too well know to be elaborated. But the benefits of opacity in ownership structure and governance is equally valuable for the investors and their limited partners.

This brings us to the second question of alternatives. I agree that cutting off the OFC route will only drive investors to incorporate in developed countries, maybe the onshore financial centres in the developed world or those with double taxation agreements. While this will not address the problem of tax base loss for the developing country, it opens the possibility of higher tax receipts for developed country governments, especially given the growing pressure on onshore financial centres to roll-back their beggar-thy-neighbour tax arbitrage policies. Anyways, given the burgeoning deficits and debts, developed countries could just as well do with those additional tax revenues. Equally importantly and immediately, given the much higher standards of transparency and disclosure requirements in Western onshore financial centres, it would lift the veil of opacity that covers the ownership and governance of these entities. 

The role of DFIs and their capital should also be to influence the markets into investing in ways that promote development objectives and transparency in corporate governance, and not go along with the markets in depriving developing countries (or governments anywhere) off their tax revenues and promoting opaque corporate governance standards and systems.

I find it incredulous that International Finance Corporation (IFC) does not have the financial muscle to significantly influence other commercial investors if it took the principled view that it would not co-invest in companies in developing countries which are incorporated in OFCs. And if all the major national government funded private sector investors like OPIC, CDC, KfW etc joined hands, then it would be a good start to limiting tax avoidance, boosting domestic resource mobilisation in developing countries, and bringing transparency into such investments.

No comments: