Tax, Capital Flight and Health
Why do tax and capital flight matter for health?
Tax and capital flight are neglected public policy issues that have a profound impact on poverty, development and health systems financing in many low and middle income countries.
Tax plays a critical role in society, fulfilling four key functions – the “four Rs” of tax:
- Revenue generation – paying for health, schools, roads and other public investments, including good regulation and administration.
- Redistribution – allowing wealth to be spread across society and promoting fairness and equity.
- Re-pricing – changing or incentivising certain behaviours (e.g. tobacco, alcohol and fuel taxes).
- Representation – tax systems strengthening can protect systems of political representation (see here).
Developing countries, already lacking resources, are often only able to capture a small proportion of their GDP – about 15% on average (compared with around 35% in developed countries), and much less in many low-income countries. In addition, taxes in many low income countries are often regressive; the poorest sections of society pay a higher proportion of their income relative to high-income groups.
The reasons for low revenue collection include the large informal nature of developing country economies and the often limited capacity of tax or revenue authorities. Revenues are further reduced by the governance of the global economy:
- Trade liberalisation: IMF and World Bank programmes in many countries have involved sharp reductions in trade taxes, which are also constrained by WTO Agreements; and other taxation has failed to make up for this.
- Tax competition: many low and middle income countries are forced to reduce their tax rates, and in particular corporate taxes in order to attract and retain foreign investment, and on savings to avoid capital flight. This has resulted in huge losses of revenue in many countries such as Zambia. (See here.)
- Transfer pricing: more than 50% of world trade is made up of transactions between different parts of the same transnational company. This allows them to set prices artificially high or low, to transfer profits illicitly into countries with the lowest tax rates.
Tax competition and transfer pricing are compounded by ‘tax havens’, which offer secrecy, low or zero taxation, and lax regulation. They allow companies and wealthy individuals to benefit from the onshore benefits of tax (public infrastructure, education, the rule of law, etc), while using the offshore world to escape their responsibility to pay for it. They also encourage corruption and a wide variety of criminal trades.
The volume of this illicit capital flow has been estimated conservatively to be an astounding US$1 trillion annually, of which half originates from low and middle income countries (see here for details). More than half of this money comes from artificial ‘transfer pricing’.
The Tax Justice Network estimates that the transfer of individual wealth alone to tax havens leads to a loss of US$ 255 billion in public revenue every year. At least US$ 50 billion of this might have accrued to low and middle-income countries. Research from the University of Massachusetts has estimated that the accumulated stock of capital flight from 40 countries over a thirty-five year period amounted to $607 billion as of end-2004.
What needs to be done?
- Require multinational companies to adopt an international standard for country-by-country reporting
- Establish binding regulations on transparency of trade and capital flows
- Strengthen the efficiency of tax revenue authorities in low income countries, coupled with improved and transparent public financial management
- Develop efficient and just tax policies
- Combat corruption and bribery. All countries should ratify the United Nations Convention Against Corruption.
- Strengthen international tax cooperation, adopt a multilateral treaty for automatic information exchange between tax authorities and introduce an international minimum tax on corporate profit
For anyone interested in reading further, we suggest
- Tax Justice: Putting global inequality on the agenda. Ed Kohonen, M & Mestrum, F, Published by Pluto Press, 2008.
- Tax Us If You Can. A report for the Tax Justice Network published in September 2005 setting out its manifesto for action.
- Closing the Floodgates. A report for the Tax Justice Network on behalf of the Leading Group of Nations on how the massive tax losses by developing countries could be stemmed.
- Mind the Tax Gap. A report showing the amount of tax not paid by major UK corporations and offering explanation as to why this happens.
- Taxing issues: Responsible business and tax. Paper written jointly with Sustainability on tax and corporate responsibility.
- Chu / Davoodi / Gupta, 2000, p. 31. Chu, Ke-young / Davoodi, Hamid / Gupta, Sanjeev, 2000: Income Distribution and Tax, and Government Social Spending Policies in Developing Countries. Helsinki: UNU/WIDER (UNU/WIDER Working Paper 214).
- Dangerous Ideas in Development – Why Are Aid Donors Frightened of Taxation?
- The Precarious State of Public Finance: Tax evasion, capital flight and the misuse of public money in developing countries – and what can be done about it. By Jens Martens, 2007.