Foreign Aid Or Tax Havens?

THE INTERTWINENDESS OF TAX HAVENS AND FOREIGN AID: AS AMBIVALENT IMPACT IN AFRICA

By Kennedy Donkor (kennedydonkor77@gmail.com) 2023.

ABSTRACT

This article provides an overview of the interconnectedness between tax havens and Africa's dependence on foreign aid. It highlights the obstacles to Africa's development posed by the lack of financial resources and the substantial funding gaps, as well as the significant capital flight and illicit financial flows experienced by the continent. It again discusses the historical evolution of tax havens and their role in facilitating tax evasion and corruption. It also explores the concept and historical background of foreign aid, emphasizing the conditions and implications associated with aid programs. Also, it further examines the negative impacts of tax havens and foreign aid on Africa, including corruption, undermining of sovereignty, profit repatriation, debt escalation, increased tax burden, and the hindrance of infant industries. It concludes by emphasizing the need for Africa to address these challenges, mobilize internal resources, promote industrialization, and prioritize domestic-led growth to achieve sustainable development.

INTRODUCTION  

The development of Africa has become a matter of public concern and discussion following the period of colonization. Various approaches have been employed to address this issue, including Import Substitution Industrialization (ISI), Structural Adjustment Program (SAP), The New Partnership for Africa Development (NEPAD), and presently Agenda 2063. However, the lack of financial resources poses a significant obstacle to economic growth and development in Africa. The existence of substantial funding gaps discourages public investments and hinders the delivery of social services. Additionally, Africa experiences significant capital flight, as highlighted in reports by the African Development Bank (AfDB) and Global Financial Integrity (GFI) (2013), as well as research conducted by Boyce and Ndikumana (2012), and Ndikumana and Boyce (2011).

Also, according to Kar and Cartwright-Smith (2010), the illicit financial outflows from Africa between 1970 and 2008 may have reached a staggering sum of US$1.8 billion. Remarkably, this amount exceeds the official development assistance (foreign aid) and foreign direct investment received by Africa during that same period. Consequently, Sub-Saharan Africa has become a "net creditor" to the rest of the world, primarily due to significant capital flight (Ndikumana and Boyce 2008). Some of these outflows end up in private bank accounts held by institutions that have granted loans to African governments. Despite the “know your customer” principle implemented by banks, politically exposed individuals (PEPs) have managed to embezzle public funds and store them in overseas private accounts. The sources of capital flight vary across different African countries, with the resource sector serving as the primary contributor to illicit financial flows in resource-rich nations (Ndikumana and Boyce 201). In fact, the International Monetary Fund (IMF) reports that approximately USD 4 billion from oil sales in Angola alone went unreported in national accounts in 2002 (AfDB & GFI 2013: 45).

The prominence of tax havens and illicit money flows has shifted from the periphery to the core of discussions on development. Until Oxfam released its publication titled “Tax Havens: Releasing the Hidden Billions for Development,” the role of tax havens in depriving developing nations of their domestic resources through facilitating illicit financial flows and tax evasion had received little attention. However, this situation is rapidly changing, and the narrative is evolving. It is increasingly clear that helping impoverished countries move beyond reliance on aid and debt requires taking measures to combat capital flight, tax evasion, and unnecessary tax exemptions. Furthermore, it is recognized that foreign aid holds governments accountable to donors, while taxation holds governments accountable to their citizens (Bräutigam et al., 2008). Tax evasion undermines this fundamental aspect of civil accountability and diminishes respect for the rule of law.

The scale of capital flight and tax evasion surpasses the number of aid flows and debt relief programs. According to the Stolen Asset Recovery Initiative of the World Bank, the cross-border movement of illicit funds stemming from criminal activities, corruption, and tax evasion reaches an estimated range of US$1 trillion to US$1.6 trillion annually. Approximately half of this flow originates from developing and transitional economies. Furthermore, Christian Aid, a British non-governmental organization, reveals that two specific forms of tax evasion-transfer mispricing within multinational corporations (MNCs) and falsified invoicing between apparently unrelated companies-resulted in a loss of approximately US$160 billion in revenue for the developing world each year (Christian Aid, 2008). Remarkably, this figure alone surpasses 150 percent of the combined aid budgets of all donor countries. These statistics demonstrate that despite receiving foreign aid, Africa ultimately repatriates a greater sum than what was initially invested.

Examining another facet of tax evasion, the Tax Justice Network provides an estimation that taxing the income generated from personal assets held in offshore accounts most of which currently evade taxation at a conservative rate could result in an additional revenue of over US$255 billion annually. These funds could be utilized for various purposes, including poverty alleviation (Tax Justice Network, 2005).

A significant development in the discourse on development is the growing recognition of the central role played by tax havens and illicit financial flows. It is increasingly evident that supporting poorer countries in moving beyond their reliance on aid and debt necessitates taking action against capital flight, tax evasion, and unwarranted tax exemptions. Furthermore, it is crucial to acknowledge that the same covert legal mechanisms employed by Multinational Corporations (MNCs) and high net-worth individuals (HNWIs) for tax evasion are also employed in a wide array of other criminal activities, including market manipulation, insider trading, illicit political contributions, embezzlement, fraud, and the payment of bribes and kickbacks (Baker, 2005).

The significance of tax havens in facilitating and promoting widespread corruption becomes evident when considering their role as operational hubs for lawyers, financial professionals, and their clients, who exploit legal loopholes and fragmented regulations (Christensen, 2008). Despite several international initiatives aiming to regulate transfer mispricing and tax haven activities, these efforts have proven largely ineffective. Unfortunately, the limited progress in combating illicit financial flows can be attributed, in part, to the narrow definition of money laundering adopted by international organizations tasked with addressing this issue. The literature indicates that tax havens and Africa's reliance on foreign aid are major obstacles to African development.

This article aims to explore the interconnectedness between tax havens and Africa's dependency on foreign aid, emphasizing how these two factors are closely intertwined.

TAX HAVENS

The history of tax havens is characterized by a tapestry of myths and fables. According to Christian Chavagneux, Ronen Palan, and their colleagues (2007), the evolution of tax havens is not a linear progression but rather a series of disruptions and transformations. These financial centers emerged in different periods and locations, serving diverse economic and political purposes. Chavagneux, Palan, and Arespacochaga assert that the origins and development of tax havens can be traced back to the late nineteenth and early twentieth centuries. Although they emerged simultaneously in multiple locations, they shared a similar concept that began to take shape in the 1980s. The proliferation of tax havens can be attributed to the postwar industrial and economic growth as well as the decolonization process undergone by several European powers (Joaquín Arespacochaga et al., 1996).

In the aftermath of World War I, countries faced the task of rebuilding their economies and raising revenue through taxation. This led to a variety of circumstances where certain territories developed tax systems designed to attract foreign capital by implementing diverse and complex fiscal structures (Nuria Badenes Pla and colleagues, 1994). Following the war, many participating countries experienced a significant increase in tax rates as a means to finance the costs of reconstruction. For instance, in France, tax rates tripled from 4% to 12%. In addition, both income and wealth taxes were imposed, prompting individuals to seek ways to evade these tax obligations. Switzerland emerged as a favored destination for individuals to relocate their assets and money in order to avoid taxation. With its long-standing tradition of banking secrecy, Switzerland discouraged government investigations into tax evasion. The majority of relocated wealth originated from neighboring countries, primarily France and Germany. By the mid-1930s, the capital moved from France was estimated to be worth between 4 and 8 billion CHF, while the German capital relocated to Switzerland was valued at 3 to 5 billion CHF in the early 1930s. Individuals from countries like Italy and the United Kingdom were also engaged in relocating their wealth, although to a lesser extent compared to France and Germany. This marked the beginning of the modern-day system of wealth relocation (Farquet et al, 2012).

The term “tax havens” lacks a universal definition, but it generally refers to offshore financial centers-countries or locations with low or no corporate taxes that facilitate the easy establishment of businesses by non-residents. Tax havens typically impose restrictions on public disclosure regarding businesses and their owners, earning them the label of secrecy jurisdictions due to the difficulty in accessing information. Despite attempts to deny their existence, it is evident that tax havens play a significant role in global financial markets. More than half of international bank lending and approximately one-third of foreign direct investment flow through tax havens. These jurisdictions, accounting for around 3 percent of global GDP, handle around 50 percent of global trade on paper. They are home to over two million international business corporations, hundreds of thousands of individuals, and millions (if not billions) of secretive trusts and foundations. The super-rich, often referred to as “HenWees” in banking circles, has shifted an estimated total of US$11.5 trillion in personal wealth offshore, resulting in an annual tax evasion amount exceeding US$255 billion.

FOREIGN AID

It is evident that countries are interconnected and interdependent due to globalization. No country exists in isolation, as they rely on each other for various needs such as credit, goods, and services that are not domestically produced. For instance, Ghana relies on countries like the United States, Canada, China, Japan, and others for items like televisions, cars, mobile phones, laptops, technical expertise, and many more. In turn, these countries depend on Ghana for commodities like cocoa, timber, gold, and packaging materials. This mutual reliance illustrates that countries require some form of aid from each other to sustain their economies.

Foreign aid serves as the international transfer of capital, goods, or services from one country to another. It can take the form of loans (concessional or otherwise), grants, or gifts. The voluntary transfer of resources from a donor country or institution to a recipient country is also considered foreign aid. Typically, foreign aid flows from developed countries to developing or underdeveloped nations. Its purpose is to benefit the receiving country or its people. Foreign aid involves the transfer of financial resources or commodities like food, military equipment, technical assistance, and training. Aid can be in the form of loans, grants, or concessional credits, and it may be utilized to promote development or alleviate poverty. Sometimes, foreign aid is channeled through international organizations such as the International Monetary Fund (IMF), African Union, Non-Governmental Organizations (NGOs), or the World Bank.

The concept of foreign aid has a historical background and can be traced back to the aftermath of World War II, particularly with the implementation of the Marshall Plan. After the war, many European countries faced dire economic situations and were in need of assistance. The United States played a significant role in supporting these countries, providing a substantial amount of financial aid to help rebuild their economies. George C. Marshall, an American statesman, was instrumental in championing this idea, which was implemented between 1948 and 1951.

The Marshall Plan, with total funding of 12.5 billion US dollars, aimed to provide support and resources to aid the recovery of European nations. This initiative accentuates that foreign aid, in its historical context, served as a means to assist countries facing severe economic challenges. The Marshall Plan demonstrated the willingness of countries to extend assistance to others in times of need. However, it is important to acknowledge that foreign aid in contemporary times may have evolved and taken on different forms. As the saying goes, “There is no free lunch,” foreign aid in modern times is often accompanied by various conditionalities and expectations. It is crucial to analyze and understand the dynamics and implications of present-day foreign aid initiatives.

TAX HAVENS AND AFRICA’S FOREIGN AID DEPENDENCE AS TWO SIDES OF A COIN.

It is unequivocally evident that the main purpose of both foreign aid and tax havens in Africa is to serve as catalysts for development, encompassing various aspects such as employment, revenue generation, poverty alleviation, and economic growth. Tax havens and foreign aid undeniably contribute to job creation, aid in times of national disasters, foster economic progress, address budget deficits, and combat diseases like HIV/AIDS, Polio, Ebola, COVID-19, Marburg virus etc. This section will explore the symbiotic relationship between tax havens and African foreign aid, shedding light on their reciprocal impact. The subsequent explanation will captivate readers with its insights.

ISSUES OF CORRUPTION

Tax havens and foreign aid have contributed to the exacerbation of corruption in Africa. The United States, for instance, serves as a prominent tax haven, attracting trillions of dollars in capital that fuels job creation within its own economy. This policy has played a pivotal role in advancing the neoliberal agenda, receiving substantial support from a collaboration between influential business figures, zealous ideologues, and assertive political leaders, (Klein, 2007).

However, the situation in Africa presents a different perspective. According to the Stolen Asset Recovery Initiative by the World Bank, illicit proceeds stemming from criminal activities, corruption, and tax evasion flow across borders, reaching an estimated range of USD 1 trillion to USD 1.6 trillion annually. Developing and transitional economies account for roughly half of this staggering amount. Furthermore, Christian Aid, a British non-governmental organization, reveals that two specific forms of tax evasion, namely transfer mispricing within multinational corporations (MNCs) and falsified invoicing between apparently unrelated companies, result in a staggering annual loss of USD 160 billion in revenue for the developing world (Christian Aid, 2008). These statistics emphasize the detrimental impact of tax havens on Africa's economic stability and financial integrity. Many politicians engage in negotiations with foreign investors, often involving tax havens, but this practice presents a significant challenge when it comes to accountability. Take Ghana, for instance, where it is perplexing to see that less than 15 percent of the crude oil extracted from the Jubilee field is actually retained by the country. Moreover, despite Africa receiving a substantial amount of foreign aid, approximately 30 billion US dollars per year, it suffers a devastating loss of 150 billion US dollars in the same year due to corruption within the continent.

UNDERMINING OF SOVEREIGNTY

The prevalence of tax havens and Africa's dependency on foreign aid undermines the sovereignty of African nations. Tax havens enable multinational companies to exert influence over governments, often pressuring them to reduce or waive taxes, citing job creation for the local youth as a bargaining chip. In some instances, these companies even resort to threatening withdrawal of their services unless their demands are met. Consequently, nation-states find themselves coerced into accepting proposals dictated by these companies.

Similarly, the sovereignty of states, particularly in Africa, is undermined by foreign aid. While countries are governed by their own laws and regulations, foreign aid challenges this principle. An example is the aid provided by the International Monetary Fund (IMF), which comes with specific conditions regardless of a country's domestic laws or policies. IMF member countries are required to follow certain guidelines and are discouraged from practicing protectionism, instead being urged to liberalize their economies, irrespective of their own ideological inclinations. This situation clearly indicates that member states are now governed by the rules set forth by the IMF.

PROFITS REPATRIATION

Profit repatriation represents a significant aspect that can be observed in both tax havens and foreign aid, acting as two interconnected elements. Companies that take advantage of tax reduction, tax holidays, or even engage in tax evasion ultimately repatriate their profits back to their home countries rather than reinvesting them in the host country where they operate. This practice demonstrates the dual nature of tax havens and foreign aid, where corporations benefit from favorable tax schemes, but their financial gains often bypass the local economy.

Multinational corporations often invest in a country under the guise of aid, aiming to assist the host nation by reducing its reliance on imported goods. For instance, Toyota has established an assembly center in Ghana to locally manufacture vehicles, thereby decreasing the need for vehicle imports. However, the primary motivation behind such investments is profit generation and subsequent repatriation. This approach can be seen as a means of exploiting Africa rather than genuinely aiding in its development. Profit repatriation by multinational companies has contributed to currency depreciation as they always convert their profits into foreign currency, further exacerbating economic challenges within the continent.

DEBT ESCALATION

Moreover, tax havens and foreign aid have contributed to the mounting debt in Africa. The inflow of money into the continent, whether through tax reduction strategies or various forms of aid, is overshadowed by the significant outflow of capital. According to Global Justice, in 2015, Africa received a total of 162 billion US dollars in the form of loans or multinational cooperation, while during the same period, a staggering 203 billion US dollars left the continent. This resulted in a deficit of 41.3 billion US dollars, perpetuating poverty and hindering development in Africa.

A significant factor contributing to this imbalance is the issue of foreign direct investment (FDI). Many FDI entities enjoy tax reductions or exemptions, but they often fail to accurately report and pay their fair share of income taxes. As a result, government revenues are reduced, leading to budget deficits. To compensate for these deficits, governments are compelled to seek loans to support their financial needs.

The cycle of relying on loans to bridge budget deficit further exacerbates the debt burden on African countries. It hampers their ability to invest in essential services, infrastructure development, and poverty alleviation programs, thus perpetuating a cycle of poverty and economic dependency.

Addressing this issue requires a multi-faceted approach. It is crucial to strengthen tax systems, improve transparency, and combat tax evasion to ensure that corporations contribute their fair share to the countries in which they operate. Additionally, diversifying the sources of revenue, promoting sustainable economic growth, and reducing dependency on loans are essential for achieving long-term financial stability and development in Africa

TAX BURDEN

Additionally, tax havens and foreign aid have contributed to an increased tax burden in Africa. Many companies operating in the region fail to accurately report their tax returns, leading governments to introduce new taxes as a means of generating revenue to govern the country. This places an additional tax burden on citizens. Similarly, foreign aid can also result in a tax burden for a country's population. When countries receive loans from organizations like the IMF, they are expected to repay the loans with interest within a specified timeframe. This puts pressure on governments to introduce new taxes in order to fulfill their debt obligations. Examples of this can be seen in Ghana, such as the introduction of the value-added tax (VAT) in 1991 and talk tax.

KILLING OF INFANT INDUSTRIES

Tax havens and reliance on foreign aid can have detrimental effects on infant industries. Countries often implement tax haven systems in an attempt to attract foreign investors. However, this approach can create an environment that favors already established companies with economies of scale, potentially leading to unfair competition and trade dumping in the host country. A concrete illustration of this can be seen in the case of Riceland Foods, one of the leading global producers of rice based in the US, which could potentially undermine the local rice production industry in Ghana, Nigeria, Togo etc. due to the influence of tax havens.

Furthermore, the dependence on foreign aid is having a detrimental impact on emerging industries, particularly in relation to the principle of free trade. Aid provided by institutions such as the IMF and the World Bank often promotes and emphasizes the principles of free market economics. However, it is evident that African countries cannot effectively compete with advanced economies in the global market, as they primarily export raw materials while advanced countries produce finished goods. This imbalance places domestic infant industries at a significant disadvantage.

Multinational corporations possess substantial resources and are thus able to provide significant support to their subsidiaries in host countries, often at the expense of domestic industries. It becomes virtually impossible for a company like Kantanka, valued at 6.5 million US dollars, to compete with giants like Mercedes Benz, with a value of 285.737 billion Euros in 2022.

CONCLUSION

The past six decades have seen Africa embracing tax havens and foreign aid programs without fully considering the implications they bring to the continent. As a result, it is crucial to give key attention and priority to addressing the issues related to tax havens and foreign aid in Africa. By doing so, African countries can effectively tackle capital flight, tax evasion, and illicit financial flows that hinder economic growth and development. Furthermore, it is important to assess the effectiveness and impact of foreign aid programs to ensure they contribute to sustainable development and are aligned with the specific needs and priorities of African nations. By addressing these challenges, Africa can pave the way for a more equitable and self-sustaining path to development.

Africans must prioritize mobilizing internal resources to drive their own development policies, projects, and programs, rather than solely relying on foreign aid. Promoting industrialization and domestic-led growth should be a central focus for African governments. Instead of creating tax havens that attract foreign companies and harm domestic industries, governments should consider providing subsidies and support to local companies. This approach would help foster the growth of domestic industries, prevent profit repatriation, and stimulate economic development within the continent.

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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