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Updating the Rich Countries’ Commitment to Development Index: How They Help Poorer Ones Through Curbing Illicit Financial Flows

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Abstract

Over the recent years illicit financial flows have attracted increasing attention from researchers and policy makers because of their negative effects on poor countries. In 2013 the mostly rich countries’ OECD acknowledged illicit flows as an issue of “central importance”. Since 2003, the Center for Global Development has been publishing the Commitment to Development Index (CDI) which ranks rich countries on their policies which affect poor countries. This paper rationalizes the inclusion of indicators of policies affecting illicit financial flows in the CDI, in addition to the previously included policies of aid, trade, migration, environment, security, technology and investment. It provides a survey of existing approaches to measuring illicit financial flows, discusses possible metrics which could be included in the CDI, evaluates how such indicators might be incorporated into the CDI, and proposes changes to current CDI indicators. The qualitative indicators of the Financial Secrecy Index emerge as the best contribution to the newly renamed and updated finance component of the CDI.
1 23
Social Indicators Research
An International and Interdisciplinary
Journal for Quality-of-Life Measurement
ISSN 0303-8300
Volume 124
Number 1
Soc Indic Res (2015) 124:43-65
DOI 10.1007/s11205-014-0779-3
Updating the Rich Countries’ Commitment
to Development Index: How They Help
Poorer Ones Through Curbing Illicit
Financial Flows
Petr Janský
1 23
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Updating the Rich Countries’ Commitment
to Development Index: How They Help Poorer
Ones Through Curbing Illicit Financial Flows
Petr Jansky
´
Accepted: 27 September 2014 / Published online: 7 October 2014
ÓSpringer Science+Business Media Dordrecht 2014
Abstract Over the recent years illicit financial flows have attracted increasing attention
from researchers and policy makers because of their negative effects on poor countries. In
2013 the mostly rich countries’ OECD acknowledged illicit flows as an issue of ‘‘central
importance’’. Since 2003, the Center for Global Development has been publishing the
Commitment to Development Index (CDI) which ranks rich countries on their policies
which affect poor countries. This paper rationalizes the inclusion of indicators of policies
affecting illicit financial flows in the CDI, in addition to the previously included policies of
aid, trade, migration, environment, security, technology and investment. It provides a
survey of existing approaches to measuring illicit financial flows, discusses possible
metrics which could be included in the CDI, evaluates how such indicators might be
incorporated into the CDI, and proposes changes to current CDI indicators. The qualitative
indicators of the Financial Secrecy Index emerge as the best contribution to the newly
renamed and updated finance component of the CDI.
Keywords Fight against poverty Policy coherence for development Commitment to
Development Index Financial Secrecy Index Financial secrecy Illicit financial flows
1 Introduction
For the past decade the Center for Global Development has been publishing the Com-
mitment to Development Index (CDI) which ranks rich countries on their contribution to
development abroad. The CDI assesses countries’ performance in seven policy areas: aid,
trade, migration, environment, security, technology and investment. The CDI does not
P. Jansky
´(&)
Faculty of Social Sciences, Institute of Economic Studies, Charles University, Opletalova 26,
110 00 Prague, Czech Republic
e-mail: jansky.peta@gmail.com
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Soc Indic Res (2015) 124:43–65
DOI 10.1007/s11205-014-0779-3
Author's personal copy
pretend to be a complete measure of the impact of the policies of rich countries on the
developing world. Rather it aims to focus on the most important policies, to the extent that
data are available. The CDI has adapted and evolved over the years, in the light of changes
in the understanding of the impact of policies on development and as a result of changes in
available data. In recent years there has been growing recognition of the harm done to
development by illicit financial flows, and the role of rich countries in providing an
environment which tolerates or discourages them.
This paper investigates whether and how indicators of illicit finance should be included
in the CDI. It explains the rationale for including illicit finance in CDI, explores the most
relevant indicators, and discusses their advantages and limitations. It proposes the
inclusion of the secrecy score of the Financial Secrecy Index (FSI) into the investment
component of CDI. This recommendation has been accepted, and the FSI has been added
to the 2013 CDI. The FSI has been added to the investment component (now renamed
finance) which assesses rich countries’ contributions to financial transparency and pro-
moting investment in poor countries. This paper rationalizes this decision and explains the
dilemmas faced with updating the composite index, the CDI, with a part of another
composite index, the FSI.
The academic literature on the CDI is relatively limited. Sianes (2013) puts the CDI
firmly within the context of policy coherence for development. He describes the CDI as the
most acknowledged and accurate way of measuring policy coherence for development as
an outcome. Sianes et al. (2013) discuss the CDI and propose the use of an ordinal
classification to rate, not rank, the performance of rich countries. These two papers together
with the methodology provided by the CDI’s authors, Roodman (2012), can serve also as
useful introductions to the CDI and its general rationale. In the past, some authors have
provided the rationale and estimation for new countries (Jansky
´and R
ˇehor
ˇova
´2013),
whereas this paper is explaining the rationale for expansion in its policy areas, namely
illicit financial flows.
The CDI has also attracted some criticism and, for example, the linear and equal
weighting of the seven components has been challenged by Sawada et al. (2004)or
Chowdhury and Squire (2006), but largely supported by Stapleton and Garrod (2008) using
an information theory approach. Furthermore, Roodman (2011) uses the CDI as an
example of composite indices to argue for the benefits of aggregation across conceptual
dimensions.
The rest of the paper is structured as follows. Section 2explains the rationale for
including policies relating to illicit financial flows in the CDI. It explains what the illicit
financial flows are, why they are bad for poor countries and what the policies of the rich
ones can do about it. Section 3introduces the existing ways of measuring illicit financial
flows and the policies of the rich countries affecting them. Section 4discusses which of
these indicators are best suited to be included in the CDI and how this update should
implemented. IT also discusses the detailed results of the 2013 CDI. Section 5concludes.
2 Development and Illicit Financial Flows
2.1 Why Include Policies Relating to Illicit Financial Flows in the CDI?
What kinds of measures can rich countries take to curtail the illicit financial flows out of
poor countries, and to ensure that the global financial system supports and does not detract
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from the development of the poorer countries? The answers to these and other questions
below involve a certain amount of conjecture.
1
While the topic of illicit financial flows is currently on the rise in research, political and
media agendas, it remains generally understudied, and a number of key research questions
have yet to be fully and rigorously answered. That is because of the topic’s illicit nature,
and the generally low availability of data, as well as the relatively limited attention that
was paid to it by researchers in the past. Although I do not repeat this disclaimer, it holds
for most of the discussed questions below. Nevertheless, even though the evidence base for
the impact of illicit financial flows’ on poor countries is not yet comprehensive, and despite
a number of uncertainties, there is now a widespread belief among many policymakers and
other experts that illicit financial flows impact poor countries and deserve more attention as
presented in Busan Partnership for Effective Development Cooperation (2011), OECD
(2013a) or, in more detail, in OECD (2013b). A case in point would be their inclusion in
the CDI.
Financial flows are crucial for poor countries and have played an important role in some
countries that have made development progress. Nevertheless, since not all financial flows
are good for development, the integration of poor countries into the global financial system
poses opportunities as well as risks.
2
Illicit financial flows seem to facilitate many of these
risks and seem to have an overall negative impact on poor countries.
Illicit financial flows are estimated to be large in magnitude and are thought to have an
overwhelmingly negative impact on poor countries. According to Kar and Freitas (2012),
illicit financial flows out of poor countries are significantly higher than aid inflows.
3
Therefore, curtailing the illicit financial flows—as well as recovering any assets already
illegally held abroad—could significantly help the financial needs of many poor countries.
4
This potential source of finance for poor countries has become even more promising in
recent years, given that aid flows from rich countries have in general not lived up to
expectations and promises (OECD 2013c). Rich-country policies can affect illicit financial
1
Paraphrasing the opening questions of Moran (2012), earlier documented in Moran (2006). Conceptually,
Moran (2012) assesses how rich country efforts can make the supposedly good (investment) even better,
whereas this article assesses how rich country efforts can make the supposedly bad (illicit flows) somewhat
better for poor countries. In a similar way that I am going to argue that not all illicit financial flows are
necessarily bad, it also holds that hardly any type of financial flows is necessarily good. For example, the
evidence of benefits of foreign direct investment for poor countries is not as strong as commonly thought
(Select Committee on Economic Affairs 2012).
2
The positive role of financial linkages is partially accounted for in the 2012 CDI’s aid and investment
components, whereas the negative role of illicit financial flows out of poor countries—largely absent from
the 2012 CDI and a topic on which there is generally not much analytical or academic work—is taken up
here and has been recently highlighted in a topical book published by the World Bank, Reuter (2012).
3
Even if the illicit financial flows were somewhat lower than these estimates suggest, they would still be
large enough to deserve more attention and curtailing them would still represent a huge opportunity for poor
countries. Also, the head of the OECD, Gurrı
´a(2008), stated that poor countries could be losing three times
the amount they receive in aid because of illicit financial flows in the form of tax evasion and avoidance
through tax havens.
4
The focus here is mostly on the prevention part, mostly because of limited focus and space, but, to some
extent, because there seems to be more perspective in reducing the flows rather than recovering the assets, as
noted by Peter Reuter on page x of Reuter (2012). Nevertheless, the recovery of assets held illegally abroad,
highlighted by the recent mass findings by a number of media organizations and reported, for example, by
Leigh (2013) in the Guardian, is an important development issue for poor countries. Asset recovery was
recently discussed by Marshall (2013) and it can, in a similar way to preventing future illicit financial flows
and therefore increasing the assets, serve as an important source of development finance. Also, successful
asset recovery seems to be a very good deterrent of future illicit financial flows.
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flows, and, given the magnitude of these flows, relatively small policy changes could make
a significant difference for poor countries.
2.2 What are Illicit Financial Flows?
There is no clear consensus on a single definition of illicit financial flows, since the word
illicit can be understood to mean both illegal and legal, but legally or morally contentious
and otherwise not fully legitimate. One good definition, used by Kar and Freitas (2012), is
the following: ‘‘Illicit financial flows are funds that are illegally earned, transferred, or
utilized and cover all unrecorded private financial outflows that drive the accumulation of
foreign assets by residents in contravention of applicable laws and regulatory frame-
works’’. But there are many reasons why finance flows out of poor countries illicitly, often
in contravention of national or international rules. An illustrative overview of these various
reasons is provided by Fontana and Hansen-Shino (2012) and discussed also by Fontana
and Hearson (2012). The word illicit in illicit financial flows is used with the meaning of
illegal or legally contentious, as opposed to licit or legal and as used, for example, by a
recent special report on offshore finance in The Economist, Valencia (2013), but the
distinction between the two types of flows is not always clear. Indeed, the definitions are a
source of controversy, as was noted by Peter Reuter (Reuter 2012).
So rather than insisting on one definition, I explain the understanding of the term
through classifying illicit financial flows into three groups: illegal (or criminal), individual
illicit, corporate illicit (or commercial). Three caveats apply. First, there might obviously
be other illicit financial flows that do not fit well in any of these groups, but these are
probably not of significant volume or importance. Second, although I do group them, illicit
financial flows are very diverse. They range from something as simple as an individual
transferring income abroad without having paid taxes, to complex money laundering
schemes involving criminal networks creating anonymous companies to transfer stolen
funds. Third, the groups are partly overlapping. For example, all of them include tax
evasion—an illegal activity practiced by both corporations and individuals.
Income from illegal activities transferred across borders is considered as the first group
of illicit financial flows. The original sources of these illicit financial flows can be both
illegal (e.g. drug trafficking) and legal (e.g. some legitimately generated funds can be
transferred in an illicit way to another country for the purpose of reducing tax obligations
in the country of origin).
5
This group includes illegal activities such as money laundering,
drug and human trafficking, smuggling, illegal trade with weapons, counterfeiting, cor-
ruption, bribery, customs fraud, or terrorist financing. These illegal activities may be
practiced by individuals, corporations, governments or other entities. Cross-border finan-
cial flows associated with any of these illegal activities are considered illicit financial
flows.
In the case of the second group, individual illicit, illicit financial flows are associated
with tax avoidance (which is not illegal), tax evasion (which is illegal) and other illicit and
illegal practices by individuals, often so-called ‘‘high net worth’’ individuals. These illicit
financial flows might not account for a high proportion of the total amounts, but they are
very visible in the media and in politics.
Corporate illicit is the third group, and a major source of illicit financial flows. A large
proportion of illicit financial flows derive from corporations that strive to maximize profit
5
Baker (2005) estimated that over 60 % of total illicit flows arise from legal commercial activities, and
most of the remainder from criminal activities.
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and avoid taxes.
6
Financial flows involved in tax evasion as well as tax avoidance, profit
shifting and other similar practices by corporations and other legal entities are considered
to be illicit financial flows. Corporations might engage in mispricing trade and other
transfers or otherwise shifting profits out of poor countries into others, including rich
countries and tax havens. Although the empirical evidence is not conclusive, transfer and
trade mispricing are estimated to be important sources of illicit financial flows and short
descriptions of these practices follow.
Transfer pricing is used by multinational corporations to price transactions between
affiliates in different countries. The practice of transfer mispricing, also known as transfer
pricing manipulation or abusive transfer pricing, involves the manipulation of transfer
prices—interest payments, license fees or payments for goods and services transferred
between subsidiaries of the same multinational company in different countries—contrary
to international agreements and often in order to reduce taxes. Therefore, transfer pricing
permits large financial flows that are viewed as illicit. For example, corporations might use
transfer mispricing to reduce their taxes and thus enrich themselves by failing to specify
properly the price at which natural resources are exported from poor countries.
Trade mispricing is transfer mispricing beyond the limits of a single multinational
corporation, and refers to transactions between both related and unrelated parties when
trade documents use false prices. While the transfer may be legal, the underlying contract
might either result from corrupt dealings between officials and corporations, or the result of
corporations optimizing their profits without adhering to the laws and best practices.
Therefore trade mispricing is deemed to be important both as a source of tax evasion and as
a channel for the movement of illicit funds.
Important source of estimates of the size of the various sources of illicit financial flows
is the research by Global Financial Integrity, Kar and Freitas (2012). OECD (2013d)
discuss profit shifting and the existing evidence on rich countries including the convincing
study of Huizinga and Laeven (2008), whereas Fuest and Riedel (2012) focus on poor
countries and rigorously investigate the role of international profit shifting in poor coun-
tries and Jansky
´and Prats (2014) provide additional evidence of profit shifting our of poor
countries.
2.3 Why are Illicit Financial Flows Bad?
Together with the excessive global financial secrecy that facilitates them, illicit financial
flows are a worldwide obstacle to global development. Although illicit financial flows are a
problem for both rich and poor countries, there are good reasons to believe poor countries
are more vulnerable to their negative effects than rich countries. Ragnar Torvik in Nor-
wegian Government Commission on Capital Flight from Poor Countries (2009) argues that
the negative effects of tax havens are greater for developing countries than for other
countries. For example, poor countries have weaker institutional, legislative and admin-
istrative capacity and do not have suitable frameworks to deal with illicit flows and with
multinational companies when it comes to transfer pricing; the government incomes are
low and their financing need high and therefore each dollar of missing tax revenue has a
6
Tax evasion breaks the law, tax planning complies with the law and tax avoidance is somewhere in
between, following the letter of the law, but not its intentions. The distinction between them is not always
clear. Furthermore, of course, there are motivations other than tax behind shifting income abroad such as, as
discussed by De Boyrie et al. (2005) or Fuest and Riedel (2012), the threat of expropriation or confiscation
of private property, economic and political uncertainty, fiscal deficits, financial repression, or devaluation.
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higher social cost in poor countries; the institutions are weaker and therefore more vul-
nerable in poor countries. Aze
´mar (2010) supports this argument by finding that that low
degrees of law enforcement are associated with higher income shifting.
The harmful impacts of illicit financial flows include hampering the poor countries’
ability to mobilize their own private and public funds and therefore lowering the amounts
of finance available for consumption and investment in poor countries, undermining their
institutions, distorting economic activity and facilitating illegal activities. There are three
broad channels through which illicit financial flows can damage poor country development,
but it is important to keep in mind that their impacts differ across the various types of illicit
financial flows and more research is needed into the empirics and heterogeneity of these
impacts.
First, illicit financial flows may directly reduce the funds available to the government.
For instance, this can happen as a result of reduced tax revenue or inappropriate spending
that could be otherwise used on public services such as schooling or health care. Together
with the assets held illicitly abroad by high net worth individuals, illicit financial flows
seem to increase the inequitable distribution of tax revenues and can contribute to income
inequality both within and between countries. Relatedly, Christensen et al. (2012) discuss
the relationship between financial secrecy and inequality. Picciotto (1992), Corbridge et al.
(1994) and Palan (2002) were among the first to discuss the various negative roles of
financial secrecy.
Second, illicit financial flows may directly reduce private funds and prevent countries
from receiving appropriate benefits from their economic production, and furthermore lower
national savings and capital available for private investment. Lower investment translates
into less infrastructure, fewer jobs and lower long-term development prospects. Motivated
by tax evasion or other crimes or incentives, illicit financial flows enable resources to flow
to informal parts of the poor countries, or to other countries. Illicit financial flows have
been discussed as a contributing factor in the recent global financial crisis and they pose a
risk to the stability of financial markets and undermine effective financial regulation, which
has been articulated, for example, by Leading Group on Solidarity Levies to fund devel-
opment (2008) and discussed by Cobham et al. (2008). Also, for some countries, illicit
financial inflows might pose bigger risks than outflows, through mechanisms like exchange
rate changes, which might be the case with countries that supply the world’s drug trade, as
discussed by Reuter (2012).
Third, and probably most importantly, illicit financial flows may harm institutions. They
can weaken the role of government, citizens’ willingness to pay taxes, undermine tax
systems’ morale and governments’ accountability towards citizens, and lower investors’
confidence and overall institutional environment. Illicit financial flows often catalyze
illegal activities or tax avoidance. For example when illicit financial flows are used to
launder the proceeds of corruption and bribery, they could help keep corrupt politicians and
other elites in their positions, sustain criminal activities, or hide the profits of their crimes.
Further negative effects associated are discussed by Shaxson and Christensen (2013). Also,
the fact that some illicit financial outflows are actually misappropriated aid inflows does
not increase support for aid and other development policies in poor as well as rich
countries.
These negative impacts of illicit financial flows on most countries are facilitated by
countries which allow illicit financial flows to thrive, such as tax havens, offshore financial
centres, secrecy jurisdictions and other countries providing similar regulatory and secrecy
services. I prefer to use the term secrecy jurisdiction, defined as a jurisdiction which
provides facilities that enable people or entities escape or undermine the laws, rules and
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regulations of other jurisdictions elsewhere, using secrecy as a prime tool. This definition is
based on U.S. Senate (2001) and Meinzer (2012) and it was discussed and promoted by
Murphy (2008).
Also some other economic entities can play an important role in illicit financial flows
such as certain banks, law and accounting firms: so called secrecy, intermediaries, pro-
viders or enablers. So although the focus in this paper is on the policies of countries, it is
important to note that the practices of other economic players, such as banks, law and
accounting firms, hedge funds and wealth managers, also have a major influence. For
evidence and discussion of some of these other economic players see Harari et al. (2012)or
a section on accounting firms in Valencia (2013). Some multinational companies also seem
to take advantage of the weaker institutional, legislative, technical and administrative
environment, or corrupt officials, in the poorer countries, to avoid paying their full share of
taxes.
7
All those who facilitate illicit financial flows enable related illegal activities and tax
avoidance and other negative phenomena that are an obstacle for the development of poor
countries.
There might be specific circumstances in which illicit financial flows are less harmful, or
in which the behavior that leads to illicit flows has benefits which should be taken into
account. For example, if a country has an especially corrupt government whose resources
are mainly used to enrich a small elite, then increasing government revenues by enforcing
taxes might lead to a worse allocation of resources than if firms and individuals find ways
successfully to avoid the burden of taxation. In these cases, the possible benefits would need
to be set against the general harm that is done by undermining the norm that companies and
citizens should generally comply with taxes that are legally and properly imposed.
This is in line with the concept of the CDI that seeks to measure the extent to which
wealthy countries pursue policies which generally contribute to shared prosperity and a
reduction of poverty: but the inclusion of a particular policy measure in the index does not
imply that this policy is always and everywhere beneficial. For example, in the aid com-
ponent, countries are given credit for increasing their foreign aid as a share of national
income, even though there are many examples in which aid has been ineffective and
sometimes harmful. Similarly, in the trade component, wealthy countries are given credit
for reducing tariffs on imports from developing countries, even though some developing
countries may be made worse off if their trade preferences are eroded by broader trade
liberalization. Similarly, the inclusion of illicit financial flows in the CDI would reflect an
assertion that such flows are generally harmful for development, not the stronger claim that
they are always and everywhere damaging. Further research is needed on whether there
might be benefits to keeping resources out of the hands of some developing country
governments and, if so, how these can be weighed against the costs, including the likely
long-term harm to local institutions and the social contract.
2.4 Which Rich-Country Policies Influence Illicit Financial Flows?
Both rich countries’ national policies and their influence over internationally agreed upon
policies influence the impact of illicit financial flows on poor countries and, more
7
One specific example is analyzed in detailed by Action Aid (2013) and another, the case of Swiss
commodity trade, by Cobham et al. (2014). These issues are more systematically discussed in the relevant
parts of this paper as well as in OECD (2013d) and more systematic empirical evidence for poor countries is
provided, for example, by Fuest and Riedel (2012) and also by Jansky
´and Prats (2014). An earlier example
of this analysis is Desai et al. (2004), who find that affiliates of a multinational based near a tax haven in
which there is also an affiliate pay the equivalent of a 20 % lower tax rate than they would do otherwise.
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generally, how the global financial system works, or does not work for poor countries.
Recent confirmation of this by rich countries themselves is found in OECD (2013a) and
OECD (2013b).
In terms of indicators of illicit financial flows, I distinguish between direct policy
measures that aim to curtail (or reduce or limit) the flows, and indirect policy measures that
aim to curtail underlying activities that generate or motivate illicit financial flows. The
focus here is more on the former, although the two are often interconnected. At one
extreme, rich countries could in theory be actively and explicitly supporting illicit financial
flows and the activities behind them. At the other extreme—considered here as the desired
one—rich countries could be doing all they can to curtail the illicit financial flows and
related activities. Rich countries should change these policies to be more favorable and less
damaging to poor countries in the sense of the concept of policy coherence for develop-
ment, as discussed by Sianes (2013). Most of the rich countries are probably currently in
between, though some seem to be closer to the former (generally including tax havens and
secrecy jurisdictions) and some closer to the latter extreme.
The policies governing financial relationships between countries create a complex
system of various multilateral and bilateral agreements, treaties and organizations with
varying degrees of formality, explicitness and accountability. These policies include
improving transparency, policing foreign corruption, international tax cooperation, and
preventing excessive transfer mispricing and profit shifting out of poor countries. Impor-
tantly, if a rich country serves itself as a secrecy jurisdiction—or lets its policies allow
other jurisdictions under a direct or indirect influence to serve as such, it helps to facilitate
illicit financial flows, profit shifting, under-declaration of income or assets by individuals
and therefore their negative impacts on poor countries, for example, by letting multi-
national corporations avoid tax payments in poor countries.
In many of the issues related to illicit financial flows it is in the very interests of rich
countries to support a global financial system that works for poor countries as well. This is
therefore one of the policy issues where the interests of rich and poor countries are, or at
least should be, often aligned. Still, there are important cases when rich countries benefit
from excessive financial secrecy or tax avoidance at the expense of a poor country, such as
when a multinational company headquartered in a rich country is using transfer mispricing
to shift its profits out of a poor country’s subsidiary to its headquarters, or when the rich
countries in question serve as tax havens or secrecy jurisdictions.
Although illicit financial flows are a problem for rich as well as poor countries, poor
countries are less likely to find themselves in a position of strength, since they have a
smaller influence on the global financial system and in shaping bilateral rules through
unilateral actions. Therefore two things are often beneficial for poor countries. First, if a
multilateral international agreement on common policy measures is reached, in contrast to
bilateral or unilateral measures. Second, if that agreement takes into account the interests
of poor countries—in contrast to some measures that have been proposed by groups or
institutions dominated by rich countries, such as the OECD.
The argument for a global approach is further strengthened by the fact that although rich
countries’ policies play an important role, each individual country’s policy has a limited
effect due to the availability of excessive financial secrecy in other countries, to which
illicit activities can be relatively easily moved. Therefore, global policy coordination and
international agreements are crucial.
Nevertheless, some, such as Peter Reuter in chapter 15 of Reuter (2012), continue to
question whether it is a good idea to focus policy efforts on illicit financial flows despite
their nature and despite their importance, if only because they are usually the consequence
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of the underlying problems such as corruption or other illegal activities that policy can, at
least in theory, deal with more directly. On the basis of the existing evidence, I believe that
although illicit financial flows are mostly symptoms of other problems identified as the
reasons behind these flows, the flows are so important and so large that—alongside dealing
with the other problems of governance or crime—there is also a need to address the flows
directly.
3 Indicators of Illicit Financial Flows
How can illicit financial flows be measured? In theory in many ways, but in practice there
are only some available currently. For example, it might seem suitable to evaluate the
impact of illicit financial flows and consider such measure for the CDI, but there are hardly
any results that could be used. Currently there are mainly two kinds of measures available,
either of the volumes of the flows or, arguably more relevant for the CDI, of the policies
and policy efforts aimed at curtailing illicit financial flows. Starting with the discussion of
the first kind, there are some metrics that look at how much finance flows out of poor
countries illicitly. Nonetheless, even though it is expanding, the empirical evidence on the
size of the flows and their determinants remains rather scarce. Ideally, there would be
reliable and comparable measures of various illicit financial flows and their impact but the
evidence base is relatively limited for a number of reasons, which include the very nature
of illicit flows and associated lack of data and low information quality. Furthermore,
academic and other researchers, as well as policy makers, have so far paid inadequate
attention to these issues given the importance of the phenomenon.
Illicit financial flows are therefore obviously difficult to measure. Still, there are dif-
ferent ways of estimating illicit financial flows, which reflect both the variety of mecha-
nisms available for tax evasion or money laundering and various methodological
approaches including surveys, case studies, interviews, statistics or composite measure-
ments. Good overviews of the direct methods of measuring illicit financial flows are in
Fontana (2010) and, more critically, Reuter (2012) and especially one of its chapters, Fuest
and Riedel (2012).
I group the estimates of illicit financial flows into three interlinked groups: tax revenue
lost, trade mispricing and new methods. This order approximately corresponds with the
development of the estimates over time and somewhat increasing rigorousness, though
possibly decreasing in how accessible the results are to the media and the general public. I
sum the three groups in the following Table 1, the more detailed description follows.
First, early research mostly by non-governmental organizations and some academics
starting in the year 2000 provided some of the first estimates of illicit financial flows, assets
held offshore and associated government revenue losses, using various methodologies that
succeeded in highlighting the importance of illicit financial flows and bringing these issues
to wider attention.
Among the first were Oxfam, Transparency International, Raymond Baker and an
organization that he founded, Global Financial Integrity, followed by Christian Aid, Tax
Justice Network and other organizations. Oxfam (2000) estimated that poor countries
suffered a yearly loss of around USD 50 billion due to tax havens and their estimate is
based on global figures for foreign direct investment and the stock of capital flight,
combining these with estimated returns to investment and interest income, along with
estimated tax rates; the sum is around USD 35 billion in untaxed foreign direct investment
and USD 15 billion in untaxed personal income. Although Oxfam (2000) considered these
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figures conservative estimates, the methodology relies on a number of questionable
assumptions and, as discussed by Fuest and Riedel (2012), their approach raises a number
of questions. Transparency International (2004) estimated that ten of the most notoriously
corrupt heads of states in poor countries may have together been responsible for as much as
USD 60 billion in illicit financial flows out of their countries during their respective tenures
in office. Raymond Baker, the director of Global Financial Integrity, in his book, Baker
(2005), estimated that more than USD 540 billion flows out of poor countries each year
thanks to a combination of tax evasion, fraud in international trade, drug trafficking, and
corruption, by combining various methods and conducting hundreds of interviews. Moti-
vated by the objective of recovering what assets might be illegally already held abroad,
Tax Justice Network (2005) estimated that the value of assets held offshore lies in the
range of USD 11–12 trillion and suggested that the global revenue loss resulting from
wealthy individuals holding their assets untaxed offshore may be as much as USD 255
billion annually [Cobham (2005) on the basis of Tax Justice Network (2005) derived that
proportions equivalent to the shares of world GDP (20 %) would imply a loss to poor
countries of around USD 51 billion a year] and it updated its estimates when Henry (2012)
estimated that a global super-rich elite had at least USD 21 trillion hidden in tax havens by
the end of 2010 and that poor countries could be losing USD 189 billion in associated tax
revenue every year. James Henry in a similar way for Oxfam (2009) estimated that at least
USD 6 trillion of poor country wealth is held offshore by individuals, depriving poor
countries’ governments of annual tax receipts of between USD 64 and 124 billion. Kapoor
(2007) is an extensive Christian Aid briefing on the problem of illicit capital flight. Reuter
(2012) report on page 5 of an odd official Chinese report estimating that around USD 100
billion were detected as being transferred from China by 16–18 thousand escaped officials
over a recent roughly 10-year period.
Second, research based on trade price data usually explores trade mispricing, which
includes transactions between both related and unrelated parties (in contrast to a more
narrowly defined transfer mispricing that includes transactions between related parties
Table 1 Summary of the three groups of the estimates of illicit financial flows
Groups of
estimates
Publishers Methods Examples
Tax revenue
lost
Non-governmental
organizations
Rough estimates of illicit
financial flows, assets held
offshore and associated
government revenue losses
Oxfam (2000), Transparency
International (2004), Baker
(2005), Tax Justice
Network (2005), Cobham
(2005), Kapoor (2007),
Oxfam (2009), Reuter
(2012), Henry (2012)
Trade
mispricing
Non-governmental
organizations and some
academics
Research using trade price
data to explore trade
mispricing, which includes
transactions between both
related and unrelated parties
Tax Justice Network (2007),
Hogg et al. (2009,2010),
Kar and Freitas (2012),
Cobham et al. (2014)
New
methods
Non-governmental
organizations, academics,
governmental and inter-
governmental
organizations
New methods of illicit
financial flows make use of
the increasing availability of
detailed data sets, statistical
apparatus and other recent
development
Huizinga and Laeven (2008),
Fuest and Riedel (2012),
Tax Justice Network
(2011)
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only, usually within a multinational corporation). Trade mispricing uses the so-called re-
invoicing process to shift profits out of developing countries either through import over-
invoicing or export under-invoicing. There are two main groups of models using inter-
nationally comparable and available data. One is the so called World Bank residual and hot
money models are based on balance of payments data. The World Bank residual model
subtracts the total of funds actually used by a country from the total of funds entering that
country and, if there are more funds coming in than funds being used, the resulting shortfall
is considered to be illicit flows. Fontana (2010) summarizes the World Bank residual
method by the following equation: Illicit flows =(increase in foreign debt ?increase in
FDI) -(financing of the current account deficit ?additions to the country’s reserves).
The hot money model considers all errors in a country’s external accounts as illicit flows.
Fontana (2010) summarizes the Hot Money model by the following equation: Illicit flo-
w=all funds coming in (credit) -all funds going out (debt). The other group of models
is based on trade data and estimates trade mispricing and trade misinvoicing, which is trade
mispricing for trade between unrelated parties.
This kind of methods have been applied in Hogg et al. (2009), who provide evidence on
the scale of trade mispricing and revenue losses for poor countries, and Tax Justice Net-
work (2007) among other projects. Hogg et al. (2010) on page 23 provide an illustrative
example with Zambia, which is a major copper exporter and whose economy is dominated
by copper. In 2008, half of Zambia’s copper exports were consigned to Switzerland as they
left the country’s customs (but according to Swiss import data, most of this never arrived at
the other end, which is interesting in its own right). Switzerland’s copper exports have
much higher declared prices than those of Zambia. Given that trade data allow compari-
sons of quite detailed categories, quality variances should not be behind all these price
differences. Were Zambia to receive Swiss export prices for its exports to Switzerland, the
total value received would in 2008 have been almost six times higher than it was, adding
some US$11.4bn to Zambia’s GDP, which in 2008 was just US$14.3bn in total. It is
possible that there is another straightforward explanation for this, but it is also possible that
this loss of revenue is at least partly the result of transfer mispricing. A further and more
general treatment of this phenomenon is discussed and analyzed in Cobham et al. (2014).
These methods capture the quantity of illicit flows by contrasting what a country claims
it imported from (or exported to) the rest of the world with what the rest of the world states
it exported to (or imported from) that given country. It is also possible to combine these
two types of models and create a composite measure. Most notably, the research by Global
Financial Integrity uses the World Bank residual and hot money models and further makes
adjustments for trade misinvoicing. Their hot money-based model estimates that the
developing world lost USD 859 billion in illicit outflows in 2010 (significantly more than
the USD 129 billion in aid by OECD countries in 2010).
Their estimates, Kar and Freitas (2012), suggest that bribery, kickbacks, and the pro-
ceeds of corruption continued to be the primary driver of illicit financial flows from the
Middle East and North Africa, while trade mispricing was the primary driver of illicit
financial flows in the other regions. On the basis of this kind of estimates, Hollingshead
(2010) estimates the loss of tax revenue to poor country governments resulting from illicit
financial outflows. She uses national corporate income tax rates to estimate the tax revenue
loss from trade mispricing. She finds the average tax revenue loss in poor countries was
between USD 98 billion and USD 106 billion annually over the years 2002–2006. This
figure represents an average loss of about 4.4 % of the entire developing world’s total tax
revenue.
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The third group is the new methods of illicit financial flows. The increasing availability
of detailed data sets, statistical apparatus and other recent development allows new
methodologies of estimating illicit financial flows to be developed. Also rather than esti-
mating the aggregate illicit financial flows, it is possible to focus on country-specific
evidence, which has been done quite well in the case of estimating the extent of profit
shifting. OECD (2013d) discuss profit shifting and the existing evidence including the
evidence of Huizinga and Laeven (2008) on the scale of profit shifting within Europe,
whereas Fuest and Riedel (2012) focus on poor countries and relatively rigorously
investigate the role of international profit shifting in poor countries. Jansky
´and Prats
(2014) build on their research by providing additional evidence of profit shifting out of
poor countries. These studies use detailed firm-level financial and ownership data for
multinational corporations to estimate the extent of profit shifting. Some, such as Richard
Murphy in chapter 9 of Reuter (2012), point out the problems with the data employed in
the above empirical analyses. Another approach, pioneered by Alex Cobham in chapter 11
of Reuter (2012), looks at the likely extent of returns and income declarations using data on
the financial positions of secrecy jurisdictions with regard to specific poor countries. Also
the Financial Secrecy Index, Tax Justice Network (2011), and other similar research
belongs to this third, heterogeneous group of new methods.
There are difficulties with these estimates; usually each estimation method has its pros
and cons, and together they have many problems. Some of the more detailed criticism of
individual methods is in Reuter (2012), Fuest and Riedel (2012) or Hines (2010). I briefly
discuss three groups of problems that most of them share: assumptions, interpretation and
policy. Most of the methods necessarily rely on strong assumptions about the sizes of flows
or assets or tax rates that can seldom be verified.
8
Many of the estimates do not allow a
straightforward interpretation, because usually there is no counterfactual available. Fur-
thermore, most of the estimates do not shed more light on specific policy measures—the
results seldom provide more guidance for policy other than a general recommendation to
reduce illicit financial flows or recover the assets held offshore.
Alternatively, it is possible to measure policies aimed at curtailing illicit financial flows,
rather than measuring the extent of flows themselves. There are various measures and
proposed systematic changes focused on curtailing illicit financial flows and, corre-
spondingly, it is possible to evaluate these efforts towards the implementation and effec-
tiveness of these measures. Many of these measures are largely influenced by rich
countries’ policies with overwhelming impact on poor countries. Also, some rich countries
such as Norway have focused their efforts on curtailing illicit financial flows more than
others.
Ideally the policies should be comprehensive and they should focus in their entirety on
excessive and often abusive financial secrecy, a crucial phenomenon interconnected with
illicit financial flows. When rich countries allow excessive financial secrecy to prevail in
the global financial system, they also allow illicit financial flows to blossom and, in effect,
significantly lower public as well as private funds and weaken the associated institutions in
poor countries.
8
One consequence of this can be that the resulting estimates are sometimes considered to be the best
available estimates, since no better alternatives exist, but are not considered to be a reflection of the reality.
In this and other ways, these methods are similar to those that estimate the losses caused by the existence of
a shadow economy—for example, Schneider (2005) estimated that developing countries could lose as much
as USD 285 billion.
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Although the role of rich-country policies in curtailing illicit financial flows and
excessive financial secrecy is difficult to identify and quantify, in the discussed respects the
most detailed, complex and overall suitable metric is the Financial Secrecy Index (FSI),
which is managed by Tax Justice Network and the latest edition was published in 2013
with the next one prepared for the autumn of 2015. The FSI is also the first ever to make a
comprehensive global effort to identify countries’ contributions to excessive financial
secrecy.
9
The FSI evaluates countries according to how much they contribute to global financial
secrecy and how much they serve as a secrecy jurisdiction, i.e. how much financial secrecy
they provide. According to the FSI, harmful financial secrecy comes in three broadly
defined flavors: the most well-known, bank secrecy (such as that offered by Austria,
Luxembourg, and Switzerland); the second, less well known, but more important on a
global scale, involves jurisdictions permitting the creation of entities (whether trusts,
corporations, foundations, anstalts or others), whose ownership, functioning or purpose is
kept secret; the third level of secrecy involves jurisdictions putting up barriers to co-
operation and information exchange. Many of these three flavors involve complex systems
that are difficult to identify. Policies that aim to regulate financial relationships between
countries are also complex and this fact is reflected in the similarly complex construction
of the FSI, especially its secrecy score that identifies a number of policy measures, both
direct and indirect.
The FSI consists of a quantitative part (so called global scale weights reflect the
countries’ contributions to offshore finance) and a qualitative part (so called secrecy score
reflects the excessiveness of financial secrecy).
10
The FSI thus captures some important
distinctions such as countries that are very secretive, but do not provide many financial
services, and countries that are not very secretive but have large offshore financial sectors.
The global scale weights are based on the International Monetary Fund’s balance of
payments data of exports of financial services, which are complemented by those of
portfolio liabilities and assets. The following are the fifteen categories that are used to
assess jurisdictions and together comprise the secrecy score:
1. Banking Secrecy
2. Trusts and Foundations Register
3. Recorded Company Ownership
4. Published Company Ownership
5. Published Company Accounts
6. Country by Country Reporting
7. Fit for Information Exchange
8. Efficiency of Tax Administration
9. Avoids Promoting Tax Evasion
10. Harmful legal vehicles
11. Anti Money Laundering
12. Automatic Information Exchange
9
A somewhat related policy index to the FSI is the Basel Anti-Money Laundering Index, which rates
countries according to money laundering and terrorist financing risk, on the basis of components including
international organizations’ ratings. Interestingly, the Index includes scores from the FSI (25 %). Because of
its composite nature (a further 10 % is for example from the Transparency International’s Corruption
Perceptions Index) and a narrow focus on anti-money laundering, the Index does not seem very suitable for
calculating illicit financial flows accurately.
10
This description of the FSI refers to its 2011 edition, but the 2013 edition is not significantly different.
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13. Bilateral Treaties
14. International Transparency Commitments
15. International Judicial Co-operation
Financial secrecy facilitates the evasion of personal income and wealth taxes on indi-
vidual assets held abroad and is well captured by the FSI, but it might be somewhat weaker
in reflecting the trade and transfer mispricing used in aggressive corporate tax planning, tax
avoidance and tax evasion practices. The FSI reflects many, but not all important factors.
To a full extent, the FSI does not evaluate countries according to how much they serve as a
tax haven in a narrow tax sense, i.e. how low their tax rates are (countries with low or zero
corporate tax include the Cayman Islands and Bermuda, while countries with preferential
tax regimes for certain types of corporations include Belgium and Switzerland, and profits
are often shifted out of poor countries to these countries in various ways) or to what extent
they indirectly help to access very low tax rates through being conduit countries, such as is
the case of the Netherlands and Luxembourg (multinational corporations invest flows via
these countries to take advantage of beneficial tax treaties, for example to avoid taxation of
capital gains or dividend payments or channel intra-group). To fully reflect these phe-
nomena, additional indicators needed to be used and, more likely, developed in the first
place. Furthermore, the FSI does not aim to evaluate countries according to how much they
serve as an offshore financial center, i.e. what level of financial services they provide to
nonresidents, but uses this information only to weight the importance of secrecy. Still,
overall, the FSI seems a straightforward indicator of rich countries’ commitment to curb
illicit financial flows.
4 How to Update the CDI with Regard to Illicit Financial Flows?
Before 2013, the CDI has not taken into account the issues discussed here, and as discussed
above, it was clear that its new editions would clearly benefit from reflecting these. A
number of questions arose. What metrics could be appropriate for inclusion in the CDI?
How do considerations of practicality, cost, relevance, and timeliness affect these choices?
The most straightforward way to update the CDI would be to include some of the existing
metrics in the CDI. Specifically, there appear to be two main alternatives, the FSI and the
estimates by the Global Financial Integrity and we discuss them below.
4.1 Include the Financial Secrecy Index or the Global Financial Integrity Estimates
in the CDI?
Let me provide original analysis and discuss the advantages and drawbacks of including
the FSI in the CDI, especially in contrast with the estimates of illicit financial flows by
Global Financial Integrity. Let me start with the upsides of the FSI. The FSI, and especially
its secrecy scores, seems very suitable for the task at hand. It provides very detailed
evaluations of countries’ policies that are country-specific, transparently researched, and
well established. The FSI was first published in 2009 and has since then been updated to
incorporate feedback and new developments. The great transparency and detail of the FSI
should give the CDI the option of including only some of the indicators included in the FSI
(secrecy score), and not others (global scale weights). Furthermore, the country coverage
should not be any problem, since the FSI covers all countries evaluated in the CDI from the
FSI’s 2013 edition onwards.
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The drawbacks of the FSI for the CDI include the fact that, at least so far, the FSI has
been published only every other year (2009 and 2011 and 2013) and so the use of the FSI
by the CDI either would require a change to annual publication of the FSI or would
necessitate the use of 1-year-old FSI results every other year in the CDI. Also, the
quantitative part (global scale weights) is not very robust due to limited data availability,
and usually relies on data 2-year-old data and estimation methods. The FSI might be
relevant for some illicit financial flows more than for others. Financial secrecy facilitates
the evasion of personal income and wealth taxes on individual assets held abroad and is
well captured by the FSI, but it might be weaker in reflecting the trade and transfer
mispricing used in aggressive corporate tax planning, tax avoidance and tax evasion
practices.
Another drawback of the FSI is common to most of the other metrics discussed here,
and to country indices more generally. In an attempt to evaluate countries, a simplified
view of the world as a collection of countries is often necessary, but this is also unhelpful
in highlighting some important issues. For example, the United Kingdom is, especially
through the City of London, a leading financial centre, but is also in one way or another
responsible for a number of other financial centres, including its Crown dependencies and
overseas territories, such as Jersey or the Cayman Islands. Another issue is that of illicit
financial flows transferred through a number of countries. The dilemma then is whether to
penalize only the country that is the final destination, or the other countries as well, and to
what extent. The important questions are whether and how these phenomena should be
reflected in the index. It could be argued that it would be partly reflected in the global scale
weights if the overall FSI was taken into account. Or it could be reflected more specifically,
maybe adjusting a country’s score according to its historical and other responsibilities.
These questions remain unanswered here as they are rather to be answered by further
research, maybe by the authors of the FSI.
Another disadvantage of the FSI—or of any similar indicator—is that it naturally
focuses more on the areas where there are available data and available policy efforts or
agreements to be evaluated. Therefore other important areas may be omitted due to the lack
of data or existing policies, although their importance would warrant inclusion. It is nat-
urally hard to estimate the extent of this bias, when secrecy and illicit activities are
involved. A potential further drawback is connected with the way the FSI evaluates
jurisdictions’ secrecy scores in cases when the jurisdiction in question consists of a number
of parts (such as the USA). Currently, it considers the worst score (Delaware in the case of
the USA) to be the representative score for the whole jurisdiction.
11
The advantages of using the estimates of illicit financial flows by Global Financial
Integrity or of a similar type are obvious from their relative success—they provide clear
figures that many people can relate to, and that the media as well as researchers and policy
makers can reference. The drawbacks might be less obvious, but seem more numerous and
important. These estimates indicate the extent of the flows rather than the policy efforts,
which are the focus of the CDI. The models rely on official statistics that are generally of
poor quality, especially in poor countries, and that do not take into account flows resulting
from illicit activities, such as smuggling or black market activity, because proceeds from
11
The FSI is not ideal or comprehensive, and an explanation of one of the reasons for this follows. The fact
that many financially secret companies based in very secretive jurisdictions through links to other less and
less secretive jurisdictions benefit from both from established markets and financial secrecy is a ladder-like
aspect of the global financial system that FSI fails to capture. When dealing with illicit financial flows, it is
often difficult to distinguish between countries of origin, conduits and ultimate destinations.
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such activities are not captured in national accounts. Also, no single model measures the
totality of illicit flows and there are no consistent models for measuring all the types of
flows including corruption money, criminal money and tax evasion. Due to data publi-
cation time lags, the Global Financial Integrity has a nearly 2-year delay in publication of
its estimates, similar to the delay to the quantitative part of the FSI. Additionally, they
provide results for individual poor countries, but not for their rich country counterparts;
these results could possibly be arranged with Global Financial Integrity or re-estimated.
All in all, after weighing up the pros and cons, the secrecy scores of the FSI seem better
suited for the CDI than the estimates by the Global Financial Integrity. Therefore, the FSI
is the best candidate to be included in the CDI and was actually included in the 2013 CDI.
4.2 Do Any Policies Currently Rewarded in the CDI Contradict the Concern About
Illicit Financial Flows and Should These Lead to Revisions?
The worry that I deal with in this section is that some of the policies rewarded in the CDI
before 2013 might be seen as contradictory to concern about illicit financial flows, but only
minor revisions seem sufficient to deal with these issues. The potentially contradictory
policies are in the CDI’s investment component. The investment component addresses five
issues: official provision of political risk insurance; avoidance of double taxation of profits
earned abroad; actions to prevent bribery and other corrupt practices abroad; other mea-
sures to support foreign direct investment; policies that affect portfolio flows, as described
in Moran (2012) and Roodman (2012). Almost all of them are relevant to the issues
discussed in this current paper, maybe with the exceptions of political risk insurance and
other measures that are relatively narrowly aspects of foreign direct investment in poor
countries.
Both the existing investment component and the FSI take into account so called double
taxation avoidance agreements, but they seem to highlight different aspects of this issue.
The existing investment component focuses on how to avoid a situation in which profits
earned in poor countries are taxed in both the poor country and the rich country. I believe
that it focuses too narrowly on this objective and ignores other important issues. The
discussion of double taxation does not properly reflect the potential costs of double tax-
ation avoidance agreements. Specifically, it does not consider how some of the details can
fuel tax competition in poor countries and incentivize them to lower their tax rates in order
to attract foreign investment. Also, and importantly for the proposed finance component,
the investment component seems not to reflect the practice where double taxation avoid-
ance agreements could facilitate so-called ‘‘double non-taxation,’’ when a corporation is
not adequately taxed in either the poor or the rich country.
As a consequence, the section on double taxation was dropped from the investment
component to avoid conflict, and also double-counting, with the FSI and to be in line with
the rationale exposed in this paper. For example, tax sparing and tax credits were positively
awarded by the CDI before 2013. The investment component gave a maximum and a high
score for tax sparing and tax credits, respectively, while the FSI gives a zero score for tax
sparing in line with the changes in international policy consensus, and only credit for tax
credit system in a spectrum of payments.
12
These specific differences stemmed from more
general ones. Neither I nor the FSI agree with the investment component’s argument for
12
On both tax sparing and tax credit, compare the investment components with the Key Financial Secrecy
Indicators 9: Avoids Promoting Tax Evasion in Tax Justice Network (2011) and on tax sparing compare it
with OECD (1998).
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low tax rates and tax holiday.
13
There are also some other common issues, but without any
conflicts.
14
4.3 Including the FSI in the CDI
With the choice of suitable indicator and revisions to the existing CDI decided, one further
indicator design issue remains to be discussed. There are two ways of incorporating
concern about illicit financial flows into the CDI: either a new 8th component based on the
FSI, or an update of the existing finance component with the FSI. There are some argu-
ments in favor of a new component, such as the fact that it would adequately highlight the
importance of illicit financial flows for poor countries, alongside the other mostly financial
components of aid and investment.
However, the arguments against the creation of a new component seem to be stronger.
First, if the new component was called, for example, finance, such a name could mislead
the reader into thinking that it is dealing with all the aspects of rich country policies
regarding finance (much of which is beyond both it and the scope of this paper), when it is
in fact focused only on illicit financial flows. In this respect, a two-word name such as
illicit finance might be more appropriate, but would break the good tradition of one-word
names for the CDI components. Also, if the FSI was integrated into the investment
component, renaming the combined metrics a finance component would seem more suit-
able. Furthermore, eight components might be simply too high a number for the CDI, as for
any other composite policy index.
Overall, the merge of the existing investment component with the FSI, giving both an
equal weight of 50 % and renaming the resulting component as finance seems the best
option. The Finance component would reward countries both for catalyzing the good flows
and for penalizing the bad flows, which is consistent with the approach of the CDI in
certain other of its existing components.
The Table 2below shows the final results of the 2013 CDI that already include finance
as one of the components. In addition, the last two columns show the two halves of this
new component. The investment support includes what is left from the previously named
investment component after excluding the double taxation section and the financial
transparency includes the secrecy scores of the FSI.
The results provide an interesting insight into the reality of policy coherence of
development. While some rich countries seem to be consistently supporting poor countries
13
For example, Moran (2012) argues that ‘‘a tax sparing agreement helps the developing country to attract
foreign direct investment by offering a low tax rate or a tax holiday’’, whereas the FSI in a draft 2013
methodology (to be available at its website later in 2013) celebrates that ‘‘countries wishing to attract foreign
investment will not feel compelled to lower the tax rates in the hope of increasing their inward stock of
foreign investment’’.
14
In the area of actions to prevent bribery and other corrupt practices abroad, there seems to be a logical
consistency between the existing investment indicators and the proposed illicit financial flow components.
They both aim to measure the policy efforts of rich countries to prevent bribery and other corrupt practices
in poor countries, but largely employ different metrics and therefore rather complement than duplicate or
even contradict each other. Furthermore, the two questions of the investment component focused on port-
folio investments view them as being generally beneficial for poor countries, for which there is not over-
whelming empirical evidence and also international policy consensus is shifting in a different direction. The
investment component focuses on inflows in poor countries and the benefits, whereas the proposed finance
component stresses flows out of poor countries and challenges and in this way the two components could
complement each other, reflecting the fact that the world is, indeed, a complicated place.
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Table 2 Results of the 2013 CDI after the update with regard to illicit financial flows
Rank Country Aid Trade Finance Migration Environment Security Technology Overall
(average)
Investment
support
Financial
transparency
12 Australia 3.84 7.13 5.75 6.90 3.82 5.05 4.66 5.31 5.87 5.63
10 Austria 2.91 5.45 4.02 7.36 6.59 6.31 5.64 5.47 5.22 2.81
10 Belgium 6.25 5.11 5.67 6.20 7.21 3.68 4.44 5.51 5.71 5.63
13 Canada 3.75 6.05 5.32 7.58 2.63 5.61 5.33 5.18 6.43 4.22
24 Czech Republic 1.43 4.95 4.52 1.26 7.50 2.01 5.42 3.87 4.82 4.22
1 Denmark 11.04 5.31 6.17 4.22 7.03 7.22 6.60 6.80 5.30 7.03
5 Finland 6.13 5.48 6.33 3.21 7.77 6.44 5.65 5.86 5.63 7.03
17 France 4.09 5.12 5.54 4.22 7.06 2.60 6.56 5.03 5.46 5.63
13 Germany 3.95 5.38 4.42 6.95 7.07 3.48 5.07 5.19 6.03 2.81
21 Greece 1.57 4.90 4.70 4.46 5.86 5.63 2.74 4.27 3.78 5.63
22 Hungary 1.10 4.97 4.82 1.57 8.04 5.51 3.21 4.17 4.02 5.63
7 Ireland 8.48 5.28 5.16 4.42 6.74 6.94 3.75 5.82 3.29 7.03
18 Italy 1.84 4.96 5.50 4.59 6.90 5.08 3.93 4.69 5.38 5.63
26 Japan 1.01 1.60 3.90 2.26 3.81 4.47 6.25 3.33 4.98 2.81
4 Luxembourg 11.89 5.21 3.58 6.83 5.76 4.90 4.14 6.04 4.34 2.81
5 Netherlands 9.74 5.90 5.00 4.20 6.94 4.22 5.20 5.89 5.79 4.22
9 New Zealand 3.35 8.10 4.20 6.72 6.02 7.13 4.43 5.71 4.18 4.22
3 Norway 10.62 1.20 5.87 9.64 2.83 7.39 5.71 6.18 6.11 5.63
23 Poland 0.88 5.47 6.05 1.84 7.57 3.67 2.53 4.00 5.06 7.03
13 Portugal 3.29 5.11 5.54 2.39 7.70 6.20 6.39 5.23 5.46 5.63
24 Slovakia 0.94 4.94 3.58 0.92 8.56 5.55 2.63 3.87 4.34 2.81
26 South Korea 1.11 -1.21 4.88 5.69 4.33 1.30 6.82 3.27 5.54 4.22
16 Spain 2.90 5.31 6.09 5.73 6.70 3.43 5.43 5.08 5.14 7.03
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Table 2 continued
Rank Country Aid Trade Finance Migration Environment Security Technology Overall
(average)
Investment
support
Financial
transparency
2 Sweden 12.78 5.89 6.17 8.99 7.80 0.28 4.51 6.63 5.30 7.03
19 Switzerland 5.38 1.80 3.15 6.43 6.13 4.58 4.88 4.62 4.90 1.41
7 United
Kingdom
6.47 5.51 5.91 5.82 7.34 5.40 4.19 5.80 6.19 5.63
19 United States 2.98 7.09 5.14 3.62 4.31 4.58 4.68 4.63 4.66 5.63
Source: The 2013 CDI results
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through both investment support and financial transparency at similar moderate (the Czech
Republic) or relatively high (Australia) levels, some other countries seem to be examples
of having incoherent policies. Switzerland, topping the overall FSI, has an average score
from investment support (4.90), but the lowest in financial transparency (1.41).
Poland is one of the countries with the highest financial transparency scores and it helps
it to substantially improve its overall ranking—it jumps ahead of its neighbors, the Czech
Republic and Slovakia, in contrast with the counterfactual situation in which only
investment support was included in the finance component. Similarly, Finland, Ireland and
Australia are among the countries, whose ranking has improved thanks to the inclusion of
financial transparency indicator. On the other hand, Switzerland and Austria are among the
countries with higher financial secrecy and therefore have worse ranking with financial
transparency included in the CDI.
5 Conclusion
Over the recent years illicit financial flows have attracted increasing attention from
researchers and policy makers because of their negative effects on poor countries. In 2013
the mostly rich countries’ OECD acknowledged illicit flows as an issue of ‘‘central
importance’’. Since 2003, the Center for Global Development has been publishing the CDI
which ranks rich countries on their policies which affect poor countries. This paper
rationalized the inclusion of indicators of policies affecting illicit financial flows in the
CDI, in addition to the previously included policies of aid, trade, migration, environment,
security, technology and investment. It provided a survey of existing approaches to
measuring illicit financial flows, discussed possible metrics which could be included in the
CDI, evaluated how such indicators might be incorporated into the CDI, and proposed
changes to current CDI indicators. The qualitative indicators of the Financial Secrecy
Index (FSI) emerge as the best contribution to the newly renamed and updated finance
component of the CDI.
Although some question whether it is a good idea to focus policy efforts on illicit
financial flows because they are usually the consequence of the underlying problems such
as corruption or other illegal activities, my conclusion is that although illicit financial flows
are mostly symptoms of other problems identified as the reasons behind these flows, the
flows are so important and so large that—alongside dealing with the other problems of
governance or crime—there is also a need to address the flows directly. Indeed, illicit
financial flows seem very high and there is thus a great opportunity for poor countries if
they can be curtailed. Even if that was the only reason, the topic of illicit financial flows
warrants further research: to advance the estimates, to learn whether and how poor
countries are affected differently by these flows compared to rich countries, and to compare
rigorously the costs of illicit financial flows with their benefits, if any.
Even with what is now known, it seems safe to say that both illicit financial flows and
financial secrecy do make most countries poorer, especially those that are already poor.
Rich countries’ policies regarding financial secrecy vary, and there is good cause for all of
them to become more responsible with respect to illicit financial flows and poor countries.
Updating the CDI with illicit financial flows seems a great contribution in this direction.
Since there is not a lot of reliable data available, the FSI is the best option for including an
indicator of illicit financial flows in the CDI.
62 P. Jansky
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Acknowledgments This work was supported in part by the Czech Science Foundation (under grant GACR
403/10/1235) and the Center for Global Development. I am grateful for comments on an earlier version to
Annie Barton, John Christensen, Julia Clark, Michael Clemens, Alex Cobham, James Henry, Mike Lewis,
Markus Meinzer, David Roodman, Nicholas Shaxson, Jan Straka, Francis Weyzig, and two anonymous
referees. I am responsible, though, for any errors, omissions or misunderstandings.
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... The interest to this problem can be explained by the failures of free economy globally. For example, Petr Janský (2015) in his rather original research suggests to introduce for further use the so-called Commitment to Development Index, which ranks rich countries according to their policies which affect poor countries. This index can be used in the process of international infrastructure formation for taxes administration and international financial flows regulation. ...
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In this chapter, the authors, operating the criteria of rigid and comfortable national taxation regimes, attempt to evaluate the stimulating impact of country's taxation systems on the dynamics of their macroeconomic growth and country's participation in the world trade. Therefore, the chapter presents the authors' conclusions concerning the efficiency of fiscal instruments for economic growth stimulation and external trade attractiveness increase as applied to the majority of contemporary states. Based on correlation of indices of tax reformations and trends of the modern countries macroeconomic development, the co-authors present their conclusions on the priority importance of the so-called “taxation comfort” in the context of country's positioning in the global rankings. Research proved a taxation effect in countries' macro-economic growth and external attractiveness stimulating, as well as this effect dependence on the level of countries material wellbeing and infrastructural conditions.
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