Written by Mukhisa Kituyi, Secretary-General of UNCTAD
The paltry sums paid in tax by some of the world’s largest companies have made headlines and provoked outrage in recent years, not least among cash-strapped governments and ordinary taxpayers in rich countries. Tax avoidance has evoked intense international debate. Major steps are being taken by G-20 and OECD members to increase cross-border information sharing on tax matters, as part of the fight to end “base erosion and profit shifting” (BEPS).
Preparations for the upcoming Addis Ababa Financing for Development Conference on 13-16 July 2015 are also raising the issue of reducing tax avoidance and illicit flows, as countries look to mobilize more domestic resources for development purposes. Countries are looking at every option possible to finance the sizable investment gap, estimated at $2.5 trillion annually in developing countries from now until 2030, needed for the ambitious Sustainable Development Goals.
In our era of austerity and aging populations, with government budgets under pressure, the role the private sector will need to play to meet these massive needs cannot be ignored. Foreign direct investment (FDI) is not altruistic in nature and should not be. It understandably looks to make a profitable return for the investors who provide it. Maximizing the development potential of FDI puts the spotlight squarely on the fiscal contribution of multinational enterprises, as an important source of revenue for governments in developing countries.
Indeed, multinationals are already some of the largest tax payers in developing countries. UNCTAD’s latest World Investment Report 2015 (WIR15) estimates the contribution of foreign affiliates to government budgets in developing countries at about $730 billion annually or 10% of government revenues on average. In Africa, for example, multinationals contribute 14% of government revenues.
At the same time, UNCTAD estimates that multinationals are shifting some $450 billion a year in profits out of developing countries, leading to estimated losses of tax revenue of around $100 billion a year in developing countries. Stopping this haemorrhage of potential development finance from developing countries is a major priority for financing sustainable development. For comparison’s sake, consider that this $100 billion dollar hole in developing country budgets is roughly equal in size to Africa’s $93 billion per year infrastructure financing gap; put another way, this lost tax revenue represents domestic resources to developing country budgets equivalent in size to more than half of outstanding donor aid commitments based on the 0.7% target.
WIR15 finds that, on average, a 10 percentage point increase in offshore investment is associated with a 1 percentage point lower rate of profitable returns in developing countries, and hence lower tax revenues for developing country budgets. But offshore investment plays an important role channeling investment to developing countries. Multinationals channel some 30% of cross-border corporate investment in developing economies through offshore investment hubs and special purpose vehicles. The challenge is to reduce the amount of taxable profits being shifted away from developing countries through offshore hubs, while not stifling the important flows of investment that these hubs facilitate.
The key question in developing countries is thus how policymakers can maximize immediate tax revenues from international investment with a sufficiently attractive investment climate while protecting the existing and future tax base?
Coherent international tax and investment policies should both protect the government revenue base and promote investment. Helping developing countries reduce harmful tax avoidance should also be an important priority for international cooperation because developing countries are less equipped to deal with highly complex tax avoidance practices, given their resource constraints and lack of technical expertise.
A set of guidelines may help realize these synergies between investment policy and initiatives to counter tax avoidance. As such, guidelines proposed by UNCTAD’s World Investment Report 2015 include the following actions:
Removing aggressive tax planning opportunities as investment promotion levers
Considering the potential impact on investment of anti-avoidance measures
Taking a partnership approach in recognition of shared responsibilities between investor host, home, and conduit countries
Managing the interaction between international investment and tax agreements
Strengthening the role of both investment and fiscal revenues in sustainable development as well as the capabilities of developing countries to address tax avoidance issues
Multinationals are among the largest taxpayers in developing countries. Ensuring they pay their fair share of tax will be vital for mobilizing the domestic resources needed to finance sustainable development.