Curbing Illicit Flows of Money

The development goals of many underdeveloped nations are seriously hampered by illicit flows of money. The money sent into those countries in the form of aid and foreign direct investment is, in many cases, dwarfed by the money that flows out as a result of money laundering, bribery, and dodgy transfer pricing. Some estimates put that outflow as high as a trillion dollars. And a lot of that money flows through, between, or within corporations.

I recently took part in a panel discussion on this topic, part of a larger event put on by a group called Academics Standing Against Poverty (ASAP).

Here are a few of what I take to be the key points, not necessarily in order of presentation, from my discussion of the topic:

Corporations have two different categories of responsibilities when it comes to curbing illicit financial flows. First, they are of course responsible for their own behaviour. Under this heading, corporations have three key obligations. First is not to game the system to avoid taxes. Minimizing taxes — even going to significant lengths to avoid taxes — may seem to be part and parcel of a manager’s obligation to maximize profits. But there is no general obligation to maximize profits, and certainly no such obligation to do so ‘at all costs.’ Even the weaker duty to ‘put shareholders first’ is a vague enough concept to be consistent with a principled stance against aggressive tax avoidance, even where taxes can be avoided legally.

A second direct obligation has to do with transparency about transfer pricing. When goods or services are being sold between branches of a multinational, the prices charged should be fair and should be rooted in a clear methodology. And total taxes paid internationally should be reported in a company’s audited annual reports. Even when gaming the system is legal, it is dishonourable.

Third, companies should have zero tolerance for bribery. Besides being corrosive to local economies, bribery is often just a lousy competitive strategy: it involves payments that cannot be guaranteed to work, and when they don’t work there is of course no recourse to the courts. Businesses generally know this, but sometimes see bribery as a necessary evil; they need to work to make it less necessary.

In addition to these direct obligations regarding their own behaviour, big companies arguably have some responsibility for the indirect effects of their operations. Major corporations support entire ecosystems of smaller businesses — suppliers, subcontractors, agents, and so on. And activities within that ecosystem can be a major source of illicit transfers. Corporations should assume some responsibility for illegal and unethical activities in their shadow. This should at least mean setting clear standards for the behaviour of the companies with which they interact, and sharing best practices. Companies are starting to do this with regard to bribery, but they should consider extending that to other areas.

Next, a point with regard to how businesses interact with governments. The least controversial, over-arching norm for business is to play by the rules of the game. Normally, governments set rules and as long as businesses play within those rules, they are at least coming close to meeting their obligations. But not all governments are equally capable of setting and enforcing the requisite rules. And the absence of clear rules doesn’t imply an absence of obligations. So, for example, the fact that the government of a small developing nation hasn’t passed regulations (as Canada and the US have done) that set standards for fairness in transfer pricing doesn’t mean that a company can be complacent.

Finally — and this bit of advice is aimed at development advocates — it is important to avoid thinking of transnational corporations as the enemy. My sense is that a significant subset of folks who are concerned with development are focused on the negative side-effects of corporate involvement in developing nations. What we need to do, though, is to harness the power of corporations rather than regretting it. Business corporations, in addition to being potent organizations, have a vested interest in reducing poverty worldwide. Anyone living on $1.25 a day makes a lousy customer and a lousy employee. Of course, corporations face a collective action problem when considering how to reduce poverty. No one corporation can do much on its own, and it’s a challenge to find ways to get long-term interests in poverty reduction to override short-term interests in profits. But still, the development community needs to see corporations as important partners. We can’t let a culture war over capitalism get in the way of helping the world’s poor.

The video of our panel discussion is now available, here:

3 comments so far

  1. Kirk on

    I appreciate most of what you said, including the often forgotten distinction between legality and morality. But I’m bewildered by the undercurrent of your view on tax minimization. It seems you consider lawful tax minimization to be unethical. You might respond, ‘no, not all tax minimization, just the aggressive type is unethical’. As a principled matter, there is no difference.

    As tax codes are designed to generate revenue by levying burdensome taxes in some places, while enabling individuals (including corporations) to pay less elsewhere, there is nothing wrong – legally nor morally – with individuals minimizing their tax burden within the letter and spirit of the law. A basic premise of legislation is that it is as it is because its drafters meant it to be that way. And a basic common law principle of taxation is that individuals may minimize their tax burden in legal ways.

    Further, refusing to minimize taxes paid might thwart governmental policy objectives. Drafters incentivize certain behaviours by enabling certain activities to generate lesser tax liabilities. Individuals are free to pass over these incentives. But this makes the incentivized activities less viable. It also makes the incentivized activities less likely to obtain, along with the government’s policy objectives in seeing them obtain.

    Finally, directors and mgmt may be legally obligated to minimize their tax burden. They are legally obligated to promote the corporation’s longterm interests. As 80% of new businesses fail within their first 5 years of life, legal tax minimization may be required for fulfilling duties to the corporation’s longterm interests.

    As a general note, I think our disagreement stems from our difference of opinion on what you call ‘gaming the system’, or what I call ‘using incentives to promote policy objectives.’ This isn’t some semantic wordplay, either.

    Thanks for another thought provoking post.

    • Chris MacDonald on

      Kirk:

      Thanks for your thoughtful comment. I agree that there is a strong prima facie obligation to minimize taxes. Generally to pay taxes unnecessarily would be a failure of a manager’s duties to the company.

      But there are situations in which aggressively pursuing tax minimization is unethical. You’re right to point out that tax breaks, exemptions, etc., serve public policy objectives that ought not be thwarted. But in at least some cases following the letter of the tax law does violate its spirit. That might not be a decisive argument against such behaviour, but it should give us pause.

      Further, while loyal service to the company (its shareholders, etc.) is important, it’s worth remembering that there are multiple ways in which a manager can expend her energies. Additional effort and personnel could be dedicated to finding new and clever methods of (legal) tax avoidance; or it could be dedicated to product-related R&D. Both would arguably represent loyal service to the company, and both might be equally good for the bottom line…but the former is less socially-valuable than the other.

      Finally, remember that this blog entry is mostly about interaction with governments of less-developed nations, governments that are often less than ideal. They may not have sophisticated legislation, regulations, and enforcement mechanisms. Your arguments make a good deal of sense in the Canadian or American context, but less sense I think in a place like Burkina Faso or Haiti or the DRC.

  2. Kirk on

    I never argued against adhering to the spirt of the law, even though that view causes problems for the rule of law, which requires that laws be published and understandable.

    I agree it is morally better, as you say, for a manager to pursue actions that both add value to the corporation and benefit stakeholders, all things considered, than actions which may cost the same but only benefit the corporation.

    ‘Aggressive tax avoidance/minimization’ is a rhetorically stylish way of saying ‘diligent adherence to the law’, provided that the letter and spirit of the law are adhered to. Perhaps you think that some less developed countries don’t levy high enough taxes.

    Are you proposing, in other words, that managers are morally obligated to make donations to countries that have low tax rates? If so, what principled basis does this have, and how do they determine ‘low’?


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