Tax Evasion, Capital Flight & Growth of Developing Countries
By Ayankeng Godlove
PhD Student & lecturer,
Accounting, Management & Marketing
University of Yaoundé II, Soa, Cameroon
(With reports of frequent financial frauds and scandals in the world, I explore, in this first of a three-part-series, tax evasion in developing countries, the difference between financial fraud, which is illegal, and tax optimisation, which is a service to its customers and remains within the limits of the law.)
Tax Evasion and Financial Fraud at a glance
In recent years, tax evasion has been on the forefront of the world’s debate. Over time, it has attracted supporters for the fight against the practice, which is widely considered as the illegal avoidance of taxes by individuals, corporations and trusts. In order to understand the concept better, this study describes tax evasion as the illegal evasion of taxes by individuals, corporations and trust and that, this activity goes to reduce states’ revenues which were meant for the provision of goods and services for the general public.
Therefore, tax evasion happens when individuals, businesses or corporations fail to comply with their tax obligation. Tax evasion, can, therefore, be defined as a crime that adversely affects a nation’s economy and the tax morale of citizens by reducing the nation’s capacity to provide government services or manage its debt and by placing a disproportionate burden on those who pay their share [(Burman, 2003;Bajada and Schneider, 2005, pp 3-5; Kirchle 2007, p.24) as cited by Braithwaite, 2009, in crime and public policy, p.381].
The importance of tax concept cannot and should not be undermined, especially with its vital role in public financing. This is because taxes are part of government revenue, which contribute to the wellbeing of the economy.
However, Corchon (1992) argues that the problem of tax evasion arises in an economy in which every taxpayer regards the output of the public sector as independent of its actions and the taxpayer can be audited by the public authority and fined, if found guilty. Thus, for a given activity, the choice is either to be on the legal side, or to become a member of the underground economy i.e. secret accounts in foreign countries, clandestine building, black markets, barter transactions, illegal gambling and prostitution, secret workshops: shoes, garments, leather, and furniture; street vendors, ‘gypsy’ cabs, rental of spare rooms.
In all these situations the parties concerned have no incentive to provide information to the competent authorities concerned. This lack of incentive is particularly severe in the case where workers involved are receiving unemployment benefits. But it is worth noting that tax avoidance and evasion are prevalent in all countries and tax structures are undoubtedly skewed by this reality. Because of this, standard models of taxation and their conclusions must reflect these realities.
In recent times, reports on worldwide tax fraud and illicit global financial flows have been appearing more and more frequently and in spite of the attention which such revelations attract, the international community is still far from an effective system of control. Braithwaite 2009 cited (Burman, 2003; Bajada and Schneider, 2005; Kirchler, 2007) that, tax evasion is a crime that adversely affects a nation’s economy and the tax morale of the citizens by reducing the nation’s capacity to provide government services or manage its debts and by placing a disproportionate burden on those who pay their share. It can be inferred; therefore that tax evasion has political, as well as, economic significance especially when there is a high level of a threat to a society’s economic security, political stability and social capital.
In addition, financial institutions all over the world have an important function in the fight against suspicious transactions, tax evasion and money-laundering practices, but most often; institutions in bordering countries fail in their duty to do so. By this failure, they – banks – especially international banks, participate in the tax evasion and avoidance mechanism of individuals and multinational corporations.
Many governments find it concerning the decline in tax revenue despite the increased international tax planning. According to some scholars, some governments’ frenzied attacks against offshore havens is due to greed and the fear of seeing their deep pockets depleted. Some other schools of thoughts believe that international crime or offshore money launderings not the problem. They believe that it is the increased use of offshore tax free companies and secretive offshore banking by the general populace that is a major headache for the avaricious high-tax regimes.
Effects of financial crime
According to Bokosi and Chikumba (2015) in their presentation to the African Civil Society, they illustrated that the global economic crisis revealed the risks African economies face on depending too much on debt financing, official development assistance and foreign direct investment. While the crisis shifted attention towards the need for greater domestic resource mobilisation, Sub-Saharan African countries still mobilise less than 17 percent of their gross domestic product in tax revenues. They found that this was due to illicit financial flows – money that is illegally earned illegally transferred or illegally utilized – and limited capacity for collecting revenues from multinational companies, particularly those engaged in natural-resource extraction. They claimed that the financial leakages amounted to official development assistance ofUS$528.9 billion over the decade ending in 2012, compared to US$348.2 billion in 2002.
The illicit resource outflows reduce the total development resource base. This forces governments to plug the gap with higher taxes that disproportionately fall on the poorest in society, as well as austerity measures that constrain the provision of public goods and services. Beyond this, the illegality of illicit financial flows is damaging to the state, as these flows are aided by bribery and theft, which ultimately undermine governance institutions.
According to Braithwaite (2005), although corporations and the public may be at odds with their “rightful” contributions to the tax system, the reality is that many companies do not pay any tax. Therefore, most member nations of the Organisation for Economic co-operation and Development countries (hereafter referred to as OECD), have seen a significant drop in the proportion of revenue collection through company tax. This is because of the global tax planning by large corporations. It can also be argued rightly that this is one of the reasons that international forums and major economies such as the G20, G8, European Union (EU), OECD and other international organisations advocating for more international cooperation and control in this area, have found it difficult to implement the related resolutions (Haldenwang & Kerkow, 2013).
It can also be argued that because of enterprise, tax evasion and avoidance have gone a long way to distorting the revenue of the government, thereby causing the implementation of taxation to be complicated for states. Wherever and whenever authorities decide to levy taxes, individuals and firms try to avoid paying them. Though this problem has always been present, it becomes more pressing in the face of globalization as this process extends the range of opportunities to circumvent
End of series one
*Please read the second article in this series to explore what other authors have written on tax evasion, capital flight, growth of developing countries and the theories of Allingham and Sandmo models: http://www.lylianfotabong.com/2015/09/25/second-series-what-have-others-written-on-tax-evasion-capital-flight-financial-frauds/
Series Three – Findings; http://www.lylianfotabong.com/2015/09/third-series-tax-evasion-capital-flight.html