IN this segment we will briefly dwell on the economic impact of the underground activities and also discuss some of the scams used in the accumulation of wealth derived from such malpractices.
Economic Impacts
Some of the pernicious effect on the economy include:
* Distortion of economic data. Since underground activities are normally hidden they are excluded from the official statistics. As a result the recorded statistics tend to misrepresent the true economic status of a country’s economy. For example, the official unemployment rate may be overstated as it fails to take into account those who may be gainfully employed in the informal sector. As a consequence policies could be misdirected towards addressing wrong issues. Hence it does not portray an accurate picture of a country’s economic growth. Similarly, the manipulation of import and export values compromises the integrity of a country’s balance of payment performance.
* Impedes economic growth. Loss of tax revenue constraints the ability of the government to finance its development programs which undermines the delivery of social services aimed at improving the wellbeing of its people. Due to lack of funds the government is left with two options. Either to increase tax to offset the loss or to borrow funds to meet the deficit which will unduly burden the taxpayers. Increase in tax will only exacerbate more tax evasion.
* Increases price of real estate. Given that a significant portion of the black money is invested in properties it inevitably causes an increase in the demand for lands and houses. Due to the exorbitant increase, it has placed the price of properties beyond the affordability of ordinary citizens thus widening the gap between the rich and the poor. Most of the disenfranchised end up living as squatters, again dependent on government for welfare assistance. Investing in real estate is seen as the most convenient and quick way of laundering black money around the world. The imposition of taxes such as stamp duty and capital gains tax may also create incentive for tax evasion through under-declaration of the transaction price. Under a collusive deal the buyer may make part of the payment in cash which is omitted from the documented sale price. Thus the black money deviously changes hands.
* Creates unfair competition among firms. The prevalence of illegal practices gives an unfair advantage to noncompliant traders who will use their competitive edge to intrude into the market share of their competitors. For example, a trader who under invoices his imports to evade Customs duty will be able to sell his goods cheaper than the compliant businesses. In the same fashion, business records are also manipulated by rogue traders by omitting receipts and falsely inflating expenses for the purposes of evading tax.
Apart from loss of tax revenue such unfair practice also discourages investment which in turn stalls economic growth. The disadvantaged trader may be compelled to resort to cost cutting measures such as laying off staff and scaling down production to stay in business.
What are some of the modus operandi used to conceal black money
One of the most popular ways to hoard black money is by shifting the ill-gotten wealth offshore. This practice is known as illicit flows. Illicit financial flows (IFFs) are illegal movements of money or capital from one country to another. Global Financial Integrity (GFI) classifies this movement as an illicit flow when the funds are illegally earned, transferred, and/or utilised. GFI estimates that in 2012, $US991.2 billion ($F2trillion) left developing countries in illicit financial outflows. In some cases, shell companies are deceptively used as a vehicle to smokescreen the movement of dirty money across the border. There are three most common modes used as conduits to disguise these illicit transfers as illustrated below.
1. Mispricing of goods
A study by GFI has found that one of the most commonly used method of moving illicit flows is by trade mispricing, since it is difficult to verify each and every transaction and its value.
The term trade mispricing refers to the mis-invoicing of international trade transactions with the intention of diverting financial resources to gain tax advantage. How it is done? Under this scam the exporter in cahoots with the foreign-based importer would declare a lower export value than the true worth of the goods shipped.
The party receiving the goods will park the balance amount in a foreign bank for a commission. Similarly, importers would overprice the goods purchased (usually those goods that are subject to zero or low rate of import duty) and the extra amount remitted would be retained in a foreign bank.
The funds are normally held in benami accounts to disguise the identity of the account holder.
2. Transfer pricing
Transfer pricing is another means which is increasingly being used by multinationals to shift their profits to their affiliates based in tax haven countries to avoid corporate tax. This has become the biggest tool for generating and transferring black money in terms of the sums that are generated through his process. Most multinational corporations seek to maximise profits artificially through maximising expenses in high tax jurisdictions and maximising revenue/income in low tax jurisdictions.
Thus, because transfer pricing enables corporations to minimise tax payments illegally and transfer the funds abroad, this constitutes illicit financial flows. According to Global Financial Integrity, the proceeds of commercial tax evasion perpetrated through trade mispricing account for an average of 54.7per cent of cumulative illicit flows from developing countries.
3. Conveyance through
human couriers
Frequent travellers are often used as carriers by others to take money out of the country for depositing it in foreign accounts.
How black money is
disposed
So what happens to the money that is reaped from illegal activities that end up stashed abroad? There are a variety of options available for their disposal, some of which include:
1) The illicit money parked abroad may come back as foreign direct investment via low-tax countries and loans. This can be done by way of round tripping which involves getting the money out of one country, say country A, sending it to country B, then diverting to country C where it is “dressed up” to enhance its appearance as foreign capital and sending it back home to earn tax-favoured profits.
2) They can be invested in assets in foreign countries.
3) Large amounts are usually kept in safe deposits in tax haven countries.
4) Part of the money can be siphoned towards making down payments for high dutiable imports. The partial payment is omitted from the invoice price. Thus reducing duty liability.
5) The hoarded funds can be bartered against purchases of (high dutiable) goods where they are undervalued to evade Customs duty.
Next week we will look at some of the measures that can be deployed by revenue agencies to reduce the incentives for underground economic activities.
* Selwa Nandan is a former adviser for trade facilitation with Oceania Customs Organisation. For feedback, email: selwa.nandan@gmail.com