In pursuit of the $21 trillion

David Cameron has one chance to target the tax dodgers—here is what he should do
March 27, 2013

Opportunities for global cooperation on tax avoidance "are grimly limited." David Cameron must use the G8 presidency to press for action © Reuters

Starbucks has done the world a great service. The techniques it used to avoid paying much corporation tax in Britain, in the 15 years since its coffee shops first appeared on the country’s high streets, while legal, have made the issue apparent and important to the British electorate. On the £3bn sales it has achieved in Britain since 1998, it has paid only £8.6m in corporation tax, a ratio that has pushed the previously arcane question of “corporate transfer pricing” to the centre of political debate. Starbucks could not have chosen a better moment: for the first time in years, the UK government has a chance to do something about it.

Starbucks’s behaviour is the tip of an iceberg of corporate opacity. We cannot know how important it is, although estimates are enormous. Private financial wealth sitting in tax havens seems to be of the order of $21 trillion, of which around $9 trillion is from developing countries. Some miniscule jurisdictions, such as the Cayman Islands, have become the legal home of trillions of dollars of corporate assets through offering the unbeatable attractions of zero taxation plus secrecy. Some industries are now dominated by tax havens: half the world’s shipping is registered in them.

It is difficult to see how this state of affairs can be in either the British or the global interest, but it can be addressed only through determined international cooperation. Abuse has persisted, and indeed escalated, because the opportunities for inter-government cooperation are grimly limited: a reflection of the deficit in global economic governance. The world must make do with such opportunities as it has and the most practical forum to get things started is the G8, the annual meeting of the heads of the world’s major economies—the US, Japan, the UK, France, Germany, Italy, Canada, and Russia, as well as those of the European Commission and European Council. This year, by rotation, Britain is the host, and will hold the summit on 17th and 18th June in Lough Erne, Northern Ireland. The G8 is a rare and precious opportunity: a private discussion among these leaders of an agreed economic policy agenda. Britain, as host, proposes an agenda which is then determined by agreement. While the presidency of the G8 does not confer authority, it offers the power to persuade. David Cameron rightly plans to keep the meetings small and closed, increasing the chances of honest discussion. Launching practical actions to tackle corporate opacity would benefit not only Britain and its G8 partners, but Africa which has suffered the consequences of tax avoidance and corruption for decades.

Does the G8 matter anymore? Hasn’t it been superseded by the G20 which includes the big emerging market economies? Given the shift in the balance of the world economy, the G20 is certainly necessary. But the governments of the G8 cannot expect others to behave in the global interest if they are not prepared to lead by collective example. If the G8 is not prepared to act, it is unlikely that the larger, more disparate grouping of the G20 can reach agreement. The G8 has lost prestige as emerging economies have grown, but it retains the capacity for politically heavyweight economic cooperation for the global benefit.

The last time Britain presided over the G8 was Gleneagles in July 2005: remember the ubiquitous white wrist bands which declared “Make Poverty History”? Tony Blair made poverty history by lining up G8 leaders to pledge doubled aid to Africa. Gleneagles was ostensibly Africa’s moment, but it coincided with the apogee of British political delusion. It followed on from The Commission for Africa, Blair’s panel and report into the future of the continent, but the sought-for headlines, “Blair saves Africa,” should more truly have read “Forget about Iraq.” Britain’s extra overseas aid nestled among the wider profligacy of Gordon Brown, then chancellor, underwritten by the credit bubble. But although the Gleneagles display of global leaders pledging more aid appeared to reflect British authority, in reality it reflected a forced solidarity, as Gleneagles immediately followed the bombings on the London Underground. Behind the show of linked hands they were seething at being bounced, and had no intention of complying.

Now is not then: in eight short years the world has turned upside down. The glamour has shifted to the G20, Western prosperity has turned into austerity and, while we decline, Africa is accelerating. China, not Britain, has become Africa’s patron: it has even donated the new headquarters of the African Union. And, as an African leader said to me, “if the West starts lecturing us on governance, we’ll say: ‘Berlusconi?’”

So if the days of profligacy and preaching are over, what is Britain’s role at Lough Erne? Are we there merely to make the tea for a bunch of superseded politicians reminiscing about former triumphs? No. No! NO!!! There is important work to do, and only these few can do it. The countries of the G8 are now themselves beset by the corporate opacity that Africa has faced for decades. By putting our own house in order, we will at last truly be doing something beneficial for the global poor. The G8 is now far more important than in the easy years of the rising tide.



Corporate opacity is hugely profitable both for those who exploit it and those who create it. It exists because it is profitable and it persists because, by design, it is below the radar. Despite being the key global economic actors, it is astoundingly easy for international corporations to conceal their cross-border transactions. Governments have done far more to curb concealed movement of workers across borders than concealed movement of corporate money. This is not because the consequences are more serious but because illicit migration, though concealed from border agencies, is apparent to voters. Tax avoidance and corruption, the consequences of corporate opacity, matter greatly. I will take them in turn.

The opacity of international corporate structures makes it much easier for companies to take advantage of the substantial differences in tax rates between jurisdictions to avoid tax legally. Some of these responses are reasonable and others socially costly. A reasonable means of corporate tax avoidance is to relocate production to those jurisdictions that offer lower tax rates. Variations in tax rates between these jurisdictions largely reflect reasonable differences in national economic policies. Potentially, to induce relocation countries could engage in a race to the bottom in taxation in which all governments lost. But more realistically the scope for relocation merely discourages egregiously damaging corporate tax rates.


The socially costly means of corporate tax avoidance is to shift profits through transfer pricing. The plain vanilla form of transfer pricing is for the subsidiary of a company which is based in a high-tax jurisdiction to sell its output to one in a lower-tax jurisdiction at a price below its true value. Or, with equivalent effect, it might buy an input that was over-priced. The result is that the arm of the company in the high-tax country will pay less tax than it would have done—often far less tax. Profits that might be taxed will have been transferred to the arm of the company in the low tax country.

The distinctive aspect of transfer pricing is that profits are shifted between countries by the artifice of accountants and lawyers rather than by relocating real economic activity. The scope for transferring real economic activity is naturally bounded by the economic characteristics of locations. While a firm might decide to relocate manufacturing from France to Britain, for example, it is not going to relocate it to the Cayman Islands.

In contrast, the scope for shifting profits through transfer pricing is unbounded: the profits from manufacturing, whether in France or Britain, can potentially all be assigned to a company registered in the Cayman Islands. Lest you think such shenanigans are hypothetical, Jersey has become the world’s largest exporter of bananas.

In turn, this distinction feeds back on whether tax competition is moderate or intense. Being major locations for real economic activity, no G8 jurisdiction has found it advantageous to cut tax rates to the floor. But there are over 700 independent tax jurisdictions, most fundamentally ill-suited to real economic activity. Since each of them can be the location for ownership of a company, competition between them has been so intense that it has remorselessly driven their corporate tax rates to zero: hence the tax havens. When combined with the web of reciprocal tax treaties originally intended to avoid double taxation, we arrive at what Pascal Saint-Amans, head of taxation at the OECD, aptly refers to as “double non-taxation.”

G8 countries woke up to plain vanilla transfer pricing decades ago. They now contain it through scrutinising the prices used for intra-corporate transactions and comparing them to third-party prices. But even plain vanilla remains a severe problem in Africa since the typical tax authority lacks the capacity to scrutinise and compare prices. For example, when I discussed with the Zambian tax authority why the copper companies were paying so little tax despite the high world price of copper, its officials ruefully explained that there were few smart accountants in Zambia, they all worked for the companies, and their job was to minimise tax. While there are transparent global markets in refined metals, with observable prices, there are no equivalent markets for ores. So, a mining company which sells its ore to a parent company abroad for refining can potentially use a notional ore price that keeps the subsidiary at break-even. Given the growing importance of resource extraction to Africa, this is of enormous consequence.

The G8 can do a lot to help Africa and other poor regions tackle this sort of corporate abuse. As the G8 tax authorities have demonstrated, mis-pricing can be contained by scrutiny. With the notable exception of South Africa, the region suffers because being divided into so many tiny jurisdictions, building the necessary capacity in each national tax authority is unviable. The remedy, both for resource extraction and more generally, is to provide guideline price information internationally, using both prices on global markets and standardised conversion factors from them to the unobservable prices such as those for ores. Officials of the OECD want to create such a database, and the G8 could give it political impetus. International companies operating in Africa would then be required either to use these guideline prices in their accounts, or to report and justify deviations.

The transfer of skills from the tax authorities of South Africa and the OECD would complement the provision of data. One idea is to establish “Tax Inspectors Without Borders,” whereby, on request, staff could be seconded for a few months. Working alongside local officials, they would combine doing with teaching. Instead of being left to find a needle in a haystack, African tax authorities would at last stand some chance of curbing transfer pricing. I am under no illusions as to the ingenuity of corporate accountants or the weak capacity of African tax authorities. This approach might only work for a decade while new avoidance strategies evolve. But the battle against tax avoidance is like that against disease: the only viable approach is repeated changing of the locks.

The problem of tackling transfer pricing in G8 countries is tougher. Plain vanilla has been superseded by more sophisticated ways of shifting profits. The technique that is now used to avoid corporate tax is not the mis-pricing of transactions but the mis-location of activities. High-value intellectual property is legally located in tax havens where it has not been produced. The essential feature of a tax haven is not that it offers low taxation, but that it is the legal home of profits that have not been generated by any real activity located there. Subsidiaries in higher-tax jurisdictions purchase the right to use intellectual property that is owned by companies registered in tax havens, thereby transferring profits to them. The Starbucks scheme, while legal, was of this type. It is difficult to determine what a reasonable rate of payment by the British subsidiary for the rights to use the Starbucks brand might be, and quite possibly the rate that Starbucks adopted was within this wide range. But should companies be free to assign the ownership of rights such as these to tax havens like the Netherlands Antilles, which have played no part in generating the value of the brand? The creation of brand value could more reasonably have been assigned to the United States, but such a profit transfer would have increased the overall tax liability of the global corporation. If that had been the alternative to leaving the profits in Britain, Starbucks might have argued—entirely plausibly—that the brand value for the British market was created by marketing conducted in Britain.

Curbing the mis-location of ownership is complicated: there is no ideal technical fix. Some academic economists go so far as to argue that corporate taxation is fundamentally flawed and should be replaced by other taxes. This is not going to happen. Practical approaches to limiting mis-location are based upon overruling the way that the corporation has assigned its profits between jurisdictions. The problem is what to put in its place.

One approach, known as presumptive taxation, is to require the company to report its global profits and then apportion them between jurisdictions according to some readily observable yardstick of activity, such as the wage bill. Despite its evident attractions it has three substantial problems: unfairness, inefficiency and politics. If wages or capital are used as the basis for apportioning profits then high-income countries will get the lion’s share of profits even if most value is added in poor countries. Applied to resource extraction it would be grossly unfair: mines are profitable because they extract natural assets which belong to the country. It would be inefficient, because assigning profits on the basis of some input would be equivalent to taxing it. Firms would respond by using less of it. But what utterly kills presumptive taxation is the politics: any observable yardstick for the assignment of profits produces winners and losers among the major countries and so the losers will block it. There is no serious prospect of a wholesale switch to presumptive taxation.

Any workable scheme has to leave tax havens as the losers while protecting the interests of countries in which real productive activity is located. There is now scope for such a deal because the US government, traditionally hostile to all presumptive taxation, has woken up to the fact that transfer pricing is costing it revenue.

A simple alternative to presumptive taxation is for companies to be required to report the apportionment of their global profits. Transparency alone could discourage much tax avoidance because it could impose damaging reputational costs. If you think this is fanciful, I quote from a recent report on tax avoidance by the Institute of Chartered Accountants. It concludes that “as with most other commercial matters on the edge of the law, an ethical judgement may need to be made as well as a legal one.” It recommends the benchmark of being willing to defend the arrangement in the public domain. Arrangements such as that of Starbucks fell short of this benchmark. The company’s management has volunteered to pay more tax on falling sales, inadvertently emphasising the current disconnection between tax and genuine profits.

If transparency is not enough, then there are possibilities that are less drastic than the full monty of presumptive taxation. For example, reporting could be supplemented by internationally agreed rules under which tax authorities are empowered to set aside the labyrinth of corporate structures. There might even be an adjudication process, with the tax authorities of countries with significant real economic activity acting together in cases of egregious disconnection between the allocation of profit and activity between jurisdictions. At present, such possibilities struggle to make progress in technical committees of the OECD at which mid-level officials from finance ministries are inclined to regard success as narrowly defending the national interest. A challenge for David Cameron is to generate political commitment on such matters that strikes a balance between empty grandiosity and the minutiae of excessive specificity. He needs to know his brief but not drown in it. A test of success is if officials grasp that returning from international tax meetings with preservation of the status quo is not victory.

Corporate opacity not only assists tax avoidance, it is the key vehicle for corruption. In Africa, and other poor regions, corruption is a huge impediment to decent economic and political governance. If corruption is the concern, does this take the G8 back to preaching? After all, isn’t it Africa that is corrupt, not us? With reason, African leaders often point out that it takes two to tango: the bribing foreign company as well as the bribed official. Corruption is illegal everywhere, but honest African political leaders and officials face overwhelming difficulties in enforcing legislation because corruption is difficult for them to prove and its proceeds are easy to conceal. In principle, it is much easier to discourage corporate bureaucracies from paying bribes than individual officials from accepting them.

One way to discipline companies is to bring transparency into their payments to governments and public officials. On payments to governments, America has recently made reporting a legal requirement for US-listed resource extraction companies, through the Cardin-Lugar amendment to the 2010 Dodd Frank Act. On curbing bribes to public officials, Britain recently made the major advance of the Bribery Act, which came into force in July 2011. Other G8 countries are already moving on one or the other of these fronts. The European parliament is considering an equivalent of Cardin-Lugar. The US has recently clarified and tightened the application of its Foreign Corrupt Practices Act. Following a bribery scandal, Canada is in the process of doing the same. The G8 has the momentum and the opportunity to move collectively to common high standards on both revenue reporting and corruption. Only common standards can provide a level playing field for international competition. Berlusconi recently protested that Italian companies should be free to bribe their way into contracts, but thankfully he will not be representing Italy at Lough Erne. Other G8 leaders are unlikely to be so shameless. Will President Vladimir Putin go along with the majority? Well, as the current host of the G20, in April Russia is convening a major conference on tackling corruption in government and business: the Russian sherpa (the senior official orchestrating it) has just invited me to address it. Manifestly, the Russians are aware that they have a reputation to live down. For this very reason they may not wish to be an obstructive exception at the G8.


Of course, for a truly level playing field, although common standards across the G8 would be a major advance, they need to extend beyond the G8. But G8 adoption is the essential precursor to the G20, the wider group which includes the main emerging economies, being prepared to take these matters forward.

Africans who say “it takes two to tango,” though right in spirit, are wrong in detail. Corruption takes three players: the briber, the bribed, and the facilitator. Corrupt money is laundered through fake companies and untraceable bank accounts. The lawyers and bankers who facilitate these transactions are not based in Lagos and Nairobi; they are in London and New York. African governments are impotent to address money laundering, but the G8 could close it down. By targeting the facilitators the G8 could complement the Cardin-Lugar and Bribery Act approach of targeting companies. A bribe would not only become more difficult to conceal as it left a company’s bank account, it would become more difficult to conceal as it entered the account of the bribe taker.

Fake companies, known as “shell companies,” are the major vehicle for bribes. A study by the World Bank of 150 known cases of grand corruption found that shell companies were important in 70 per cent of them. A shell company conceals its real—“beneficial”—owners. It is astoundingly easy for lawyers to establish such companies. Researchers conducting a recent experimental study for Griffith University in Australia sent more than 7000 emails to law firms—“corporate service providers”—around the world requesting one to be set up. Included in some emails, on a randomised basis, was incriminating information indicative of corruption: a premium on normal fees was offered to maintain secrecy. In these cases, the number of law firms demanding identity documents (an international requirement allowing the owner to be traced) fell. G8 countries were high in the global league table of the legal lackeys of embezzlement. The study concluded:

“Untraceable shell companies are in practice widely available. Despite their regular pronouncements to the contrary, rich, developed countries are delinquent in enforcing the rules on corporate transparency, doing significantly worse than developing countries, and three times worse than the oft-reviled tax havens. Even customers who should be obvious corruption and terrorism financing risks to any provider exhibiting any risk-sensitivity are still regularly offered untraceable shell companies.”

Untraceable beneficial ownership of companies, whether based in tax havens or elsewhere, has been a concern of the Financial Action Task Force. The FATF is a technical group of 34 major countries with the power to blacklist those financial systems that do not meet adequate standards of transparency. Since September 2001 its primary concern has been to curb terrorist finance where it has had some success. While the FATF can set rules and make recommendations, it is up to each country how vigorously they are implemented. Beyond the high-profile issue of terrorist finance, the FATF has lacked the coordinated high-level political support for its work to be sufficiently effective. Compliance with its anti-money-laundering procedures has tended to degenerate into a culture of box ticking. The law firms and banks to which the rules apply have not been sensitised to why they matter.

In the tussle between scrutiny and profit, scrutiny can only win if those tasked with doing it recognise its social value. For the beneficial ownership of all companies to become either a matter of public record or at least readily ascertainable by legitimate authorities, a new approach is needed. It would combine tighter responsibility for reporting, increased investigative effort, tougher penalties, and automatic exchange of information.

The responsibility for reporting should rest with people who have something to lose from misrepresentation. A minimalist approach would be for the lawyers empowered to establish companies as “legal persons” to be subject to public certification as fit and proper persons to perform their duties—as with notaries and doctors. They would then face the risk of being struck off and unable to practice. Currently, we regulate the birth certificates of people far more closely than the birth certificates of companies.

There is an undoubted need for a major increase in investigative effort. In Britain the authorities currently investigate only around a thousand of the 280,000 annual reports of transactions which give grounds for suspicion. The deterrent effect of penalties for non-compliance can be increased both by increasing those penalties and by making conviction easier. For the typical lawyer the threat of jail is likely to be a more potent deterrent than that of a fine. In the context of a low probability of detection, fines are liable to be factored in as a cost of business. The most straightforward means of increasing the risk of conviction is to lower the threshold of evidence by imposing strict liability—which means no excuses are accepted. We apply strict liability if a firm pollutes a stream, but not if a lawyer registers a company without ascertaining beneficial ownership. Finally, while money can be moved between jurisdictions at the speed of light, the exchange of information between authorities is voluntary and so currently sometimes moves at the pace of an uncooperative bureaucrat. Information needs to be stored in compatible systems and, subject to safeguards, exchanged automatically.

Corporate opacity is not inadvertent: it is the cumulative achievement of the sustained effort of some of the most brilliant professional minds on the planet. These people should hang their heads in shame. In advanced economies their actions undermine the tax base and the public spending essential for the maintenance of decent living standards. Worse, their actions bleed the world’s poorest societies of tax revenues, and facilitate the mass looting of the public purse. The resource booms of the current decade are Africa’s decisive opportunity: if the history of plunder were to be repeated it would be a tragedy of awesome proportions.

Professional brilliance has enabled the accountants, lawyers and bankers who facilitate these evils by exploiting outdated systems to stay within the letter of the law. This is sufficient to unshackle greed from the constraints of conscience. That is why we need a top-level push from the G8; a push which David Cameron is in pole position to initiate. Although London is a major centre for the construction of corporate opacity, it would be a mistake for Britain to act alone. While it might look heroic, it would not address the problem facing poor countries—shell companies would merely shift elsewhere. But by offering to put our house in order as long as other major financial centres do the same, we face the other G8 leaders with an opportunity that they would be irresponsible not to seize. Even once launched, it may take civil servants some years of coordinated and laborious effort to bust corporate opacity. But without focused and determined leadership at Lough Erne it will not get started.

Paul Collier will be taking part in a Prospect roundtable on tax avoidance