Some black myths about Indians' black money holdings

The avalanche of corruption scandals in recent months in India, and reports of many thousands of crores in black money stashed abroad, have justifiably triggered an uprising in India.

Yet some of the lamentation that has driven this uprising is based on what scholars say are “myths” purveyed in the Indian media over the issue of black money.

Dev Kar, lead economist at the Global Financial Integrity (GFI), a policy advocacy group working to curtail cross-border flow of illegal money, reasons that forpolicy discussions to be sharply focussed on curtailing the generation and transmission of illicit capital, these myths should be dispelled.

“We ?nd media reports ?oated by some academics that Indian nationals hold around $1.4 trillion in illicit external assets to be wildly exagerrated,” notes Kar.The back-of-the-envelope method used to derive the $1.4 trillion figure is deeply ?awed, he adds.

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That figure was arrived at by extrapolating GFI’s estimated average illicit out?ows over the period 2002-06 - which was $22.7 billion per year - and multiplying it by 61 (for the number of years from independence to 2008).

It is erroneous, reasons Kar, to apply annual averages to a long-time series particularly when illicit flows fluctuate sharply from year to year. Indicatively, India’s GDP from 1950 to 55 was slightly less than $22 billion a year, which would imply that more than 100% of GDP was transferred out as black money during that period, which is an “absurd proposition”.

[caption id=“attachment_25333” align=“alignleft” width=“380” caption=“More than half of the illicit outflows from developing countries during that period were accounted for by “trade mispricing” or “transfer pricing”.AFP Photo”]  [/caption]

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China fares worse

Whatever the figure, there’s no denying, of course, that India is being bled dry by black money outflows. Yet, bad as it is, particularly for a middling developing country, India doesn’t figure in even the top 10 countries within Asia in terms of “illicit outflows”. China is grappling with a far worse problem on this score - even after accounting for the fact that its economy is thrice as large as India’s.

GFI reported earlier this year that Asia accounts for the largest outflow of “illicit outflows” from developing countries. And within Asia, China is far and away the country with the highest illicit outflow.

How Big Business drives black money

More strikingly, black money isn’t generated only from political bribery and kickbacks. It is generated on a rather bigger scale when Big Business, which operates across countries, dodges taxes and transfers profits to low-tax jurisdictions.

GFI defines “illicit flows” as capital that is “illegally earned, transferred, or utilised” - which covers all unrecorded private financial outflows that drive the accumulation of foreign assets by residents in contravention of applicable capital controls and regulatory frameworks.

In other words, illicit flows may involve capital that is earned through legitimate means such as the profits of a legitimate business. What makes the outflows illicit, GFI notes, is the transfer abroad of that profit in violation of applicable laws (such as non-payment of applicable corporate taxes or breaking of exchange control regulations).

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Indicatively, China, on top of the list, witnessed illicit outflows of $2.18 trillion between 2000 and 2008; India, ranked 15th, saw cumulative illicit outflows of $104 billion.

India’s rank on this black list actually fell from 5th place (in an earlier report from GFI). But that didn’t happen as a result of anything that India did right. India’s relative ranking fell largely because illicit outflows from a few oil-producing countries - in West Asia, Latin America and Asia - surged during this period.

The top 10 countries ranked on cumulative illicit outflows from 2000 to 2008 accounted for 70% of all such outflows from all developing countries during that period.

The role of “trade mispricing”

More than half of the illicit outflows from developing countries during that period were accounted for by “trade mispricing” or “transfer pricing”, which happens when corporations operating across borders shift profits to jurisdictions where they are taxed at a lower rate (and by shifting costs into high-tax countries), thereby depriving developing country governments of tax revenue on operations on their territory.

Earlier this month, the International Monetary Fund outlined the modus operandi of this tax dodge measure:

“A company can avoid taxes by establishing an offshoot in a low-tax jurisdiction such as an offshore financial center and having the entity engage in transactions with headquarters. This can shift corporate income-which is usually taxable-into the low-tax jurisdiction.

Tax evaders use tax havens in three ways:

Hiding income: Receiving income in cash or another non-traceable form, and depositing it in an account in a tax haven (or having the payer deposit the money directly into an offshore account), without declaring the income in the home country.

Hiding investment income: Depositing legal money in an offshore account but not declaring the interest or other investment income that is derived from it.

Shifting taxable income: Setting up a company in a tax haven and making payments to this company for nonexistent services or purchases whose price is exaggerated-known as aggressive transfer pricing-to shift taxable income to the tax haven.”

Panties for $739 a dozen!

This aggressive “transfer pricing” has led to some bizarre trade prices, which are manifestly intended for tax dodging. Toilet tissue from China was once priced at $4,121 per kg ( page 68 of this report), briefs and panties from Hungary were priced at $739 a dozen, plastic buckets from the Czech Republic were priced at $972, and ball-point pens from Trinidad at $8,500 apiece!

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China’s millionaires are leaving

In China’s case, while the number of millionaires has increased in recent years, so also has the “rich drain” - the number of millionaires emigrating overseas, which some see as “taking their money and running away” from China.

Zhong Dajun, a Chinese academician who belongs to the New Left movement in China (which opposes economic reforms), told the Chinese media that the wave of “investment immigration” of rich Chinese people was a wealth drain - and had to be stopped. Zhong said:

“We have been working hard to develop the economy over the past 30 years, but now these elite members of society are fleeing with the majority of the wealth. The loss may be even higher than all the foreign investment we have attracted. It is as if, when the time of harvest comes, we find the fruits have all gone to others’ baskets.”

Black money is ’national asset’

One of Baba Ramdev’s demands, as part of his anti-corruption crusade, was that the government should declare all black money held overseas as “national asset” and seize them. But Kar of GFI notes that such attempts to “con?scate illicit funds through a unilateral declaration of ownership will fall ?at because as far as owners of illicit capital are concerned, the government declaration does not bring about a material change in their situation.”

The funds continue to be illicit as before and owners continue to have access to their illicit fundsoutside the country in full cooperation of secrecy jurisdictions without any knowledge of the Indian authorities.

If matters were so simple, reasons Kar,such unilateral declarations by governments would have ensured that there were no illicit funds left in the world.