Global Financial Integrity


Nipping It in the Black

Dev Kar

It’s Better to Adopt Measures to Tighten the Creation of Black Money than to Be Quixotic about its Return

This article was originally published by The Indian Express.

Despite India’s support for it at the G-20, the OECD’s automatic exchange of financial information (AEFI) regime is riddled with loopholes that make its usefulness questionable.

Successive governments have attempted to curtail the black money menace through policy action and moral suasion. But the recent slew of measures, including bilateral and multilateral initiatives — most recently, India and the United States signed an agreement under the American Foreign Account Tax Compliance Act — is perhaps the most far-reaching in memory. Black money or illicit financial flows violate laws in their creation, utilisation or transference. They have had a pernicious influence in India since Independence — from the financing of elections to that of terrorism against the state.

Policy actions against black money are focused on either its recovery from abroad or curtailing further transfers. In our experience, countries benefit more by curtailing the present rate of black-money creation than by trying to recover funds lost in the past. Numerous countries have found that getting back illicit funds and collecting unpaid taxes is an arduous, time-consuming and expensive task. In addition, the very real potential of punitive action on holders of such ill-gotten assets strongly discourages voluntary disclosure. Little wonder that the World Bank’s Stolen Asset Recovery programme has, since its inception in September 2007, assisted in recovering only a minuscule portion of illicit assets stashed abroad. This, notwithstanding the full support of the bank’s near-universal membership of states and its own considerable human and financial resources in the fray. All this goes to show that it is far better to adopt policy measures to tighten the creation and transfer of black money than to be quixotic about its return.

The recently passed Undisclosed Foreign Income and Assets (Imposition of Tax) Act is an attempt in that direction. The legislation states that those voluntarily declaring unaccounted income or assets would have to pay a flat 30 per cent tax and a similar penalty, while wilful tax evaders would be liable for 10-years rigorous imprisonment. However, for this law to encourage voluntary disclosure of secret offshore accounts, owners must come to believe that the government will discover their offshore holdings. At present, the best strategy for India to discover those accounts will be to enter into exchange agreements with other countries under the OECD’s automatic exchange of financial information (AEFI) global treaty regime.

Despite India’s support for it at the G-20, the OECD’s AEFI regime is riddled with loopholes that make its usefulness to the undisclosed foreign income act questionable. Under the current implementation timeline, the first exchange of information is at least two years away. Additionally, information on beneficial, or actual, ownership of deposit accounts worldwide is scanty, and these information gaps are unlikely to be filled quickly. India has, since 2009, required banks to collect information on beneficial ownership, but actual implementation has thus far been dismal. Even though the Reserve Bank of India has issued a number of banking guidance circulars, most financial institutions have yet to comply. Moreover, subscription to the AEFI regime is voluntary, and the OECD cannot coerce countries to sign up. Tax havens are under pressure to join, but it is not clear when we could expect the major ones to do so. The most important loophole is that the AEFI only requires exchange of information if a national has a 25 per cent or greater stake in that account. If an account holder has less than 25 per cent interest in the total funds in that account, the country or jurisdiction would not be required to share information on beneficial ownership with India. Therefore, holders of black money abroad could simply disperse their funds into smaller deposit accounts below the OECD threshold in multiple jurisdictions in order to avoid detection. We can expect the world’s labyrinthine shadow financial system to help them to do so in relative anonymity.

There has been scant progress against tax haven secrecy. Aided by little or no regulatory oversight, tax havens have been absorbing illicit funds from poor developing countries for decades. Research at Global Financial Integrity shows that over the period 2005-11, the assets of private residents of developing countries grew twice as fast as those of advanced countries. Major international banks are not far behind when it comes to opacity. A number of the world’s foremost banks have been in the news recently for their alleged role in one money-laundering scheme or another. Typically, since the bank’s top managers are not held personally responsible, they do not go to jail. The banks pay a fine that amounts to little more than a slap on the wrist and business continues as usual.

Another gambit by the Narendra Modi government to address the problem, incentives for e-payment of tax, is also a questionable effort to curtail the circulation of black money. At first glance, it would appear that such targeted measures could work, given that a large portion of business transactions in India is cash-based, making it difficult to detect black money. But since only a sliver of India’s labour force pays income taxes, the incentive to encourage payment by bank card can only have a limited impact on black money circulation. Furthermore, illicit profits arising out of a cash transaction may well exceed any tax incentive the government can provide through the use of bank cards. In such cases, the risk-reward equation would still work out in favour of those operating in cash.

According to the World Bank, there are six dimensions to overall governance: absence of violence, voice and accountability, strength of institutions, government effectiveness, control of corruption and the rule of law. The specific measures to curtail black money announced recently need to be buttressed by systemic policies to stren-gthen each of the other aspects of governance. India will also need to continue international efforts at appropriate forums to restrict the absorption of black money by foreign financial institutions and require the reporting of such accounts. Given the significant policy challenges on multiple fronts, the path to redemption has
often been littered with the carcasses of good intentions.

The writer is chief economist, Global Financial Integrity, Washington DC, and a former senior economist at the IMF