/ 13 September 2019

Fake FDI tops global growth

Fake FDI tops global growth
(John McCann/M&G)

Pope Francis this week exhorted the political leaders of Mauritius, known as a tax haven and enclave for shell companies, to promote policies that reduce income inequality and to reject “the temptation of an idolatrous economic model”, according to the National Catholic Reporter.

In a visit to the country, the pontiff pointed to economic growth that he said “does not always profit everyone” and “feels the need to sacrifice human lives on the altar of speculation and profit alone”.

Earlier this year, the Tax Justice Network (TJN), which campaigns for multinationals to be fairly taxed and for an end to tax havens, ranked Mauritius in 14th place in its corporate tax havens score. It gave Mauritius an 80 out of 100 in terms of how corrosive it is as a tax haven.

The pope warned booming Mauritius against an “idolatrous economic model”, the Religious News Service reported from the Vatican.

The service reported that the country has witnessed tremendous economic growth in the past decade, thanks to savvy financial policies that promoted tourism and substantial foreign investments. Although Mauritius can be described as “an oasis of peace”, Francis said it must still “remain vigilant” against an economic model that feels the need to sacrifice human lives on the altar of speculation and profit alone, considering only immediate advantage to the detriment of protecting the poor, the environment and its resources.”

On the same day as the pope was warning against economic idolatry, the International Monetary Fund (IMF) published an article on its website that said as much as 40% of global foreign direct investment (FDI) is phantom, with multinationals swishing funds through tax havens to minimise the tax they pay.

“A few well-known tax havens host the vast majority of the world’s phantom FDI.
Luxembourg and the Netherlands host nearly half. And when you add Hong Kong, the British Virgin Islands, Bermuda, Singapore, the Cayman Islands, Switzerland, Ireland and Mauritius, these 10 economies host more than 85% of all phantom investments,” wrote the authors — Jannick Damgaard, an adviser to the IMF’s Nordic-Baltic office; Thomas Elkjaer, a senior economist in the IMF’s statistics department; and Niels Johannesen, a University of Copenhagen economics professor.

“Globally, phantom investments amount to an astonishing $15-trillion, or the combined annual GDP [gross domestic product] of … China and Germany. And despite targeted international attempts to curb tax avoidance — most notably the G20’s Base Erosion and Profit Shifting initiative and the automatic exchange of bank account information within the Common Reporting Standard — phantom FDI keeps soaring, outpacing the growth of genuine FDI,” the authors wrote.

“In less than a decade, phantom FDI has climbed from about 30% to almost 40% of global FDI. This growth is unique to FDI. According to a 2018 study by Philip Lane and Gian Maria Lane, FDI positions have grown faster than world GDP since the global financial crisis, whereas cross-border positions in portfolio instruments and other investments have not.”

Phantom FDI is largely hosted by a few tax havens, but virtually all economies — advanced, emerging market, and low-income and developing — are exposed to the phenomenon. Most economies invest heavily in empty corporate shells abroad and receive substantial investments from such entities, with averages across all income groups exceeding 25% of total FDI, the authors wrote.

The TJN tweeted in response to the paper: “How much does corporate tax abuse cost us all? While the IMF puts the global losses at $600-billion each year, using more robust data we estimate it is $500-billion — with lower-income countries losing about $200-billion.

“The World Bank estimates that 650 million people live below the international poverty line of $1.90 a day. The $500-billion in tax dodged by multinational corporations is enough to give 650 million people $2.10 a day each and, theoretically, eliminate extreme income poverty.

“To truly stop the epidemic of corporate tax avoidance governments must start taxing multinational corporations based on where their employees work, not where their ledgers hide. This is known as the unitary tax approach, [under which] governments treat a multinational corporation as a group made up of all its local subsidiaries, instead of treating each local subsidiary as an individual entity,” the TJN tweeted.

“No matter which road policymakers choose, one fact remains clear: international co-operation is the key to dealing with taxation in today’s globalised economic environment,” the IMF study noted.


Tax avoidance: Double Irish and a splash of Luxembourg

In the case of Ireland, the corporate tax rate has been lowered substantially, from 50% in the 1980s to 12.5% today, the IMF paper said.

“In addition, some multinationals take advantage of loopholes in Irish law by using innovative tax engineering techniques with creative nicknames such as “double Irish with a Dutch sandwich”, which involves transfers of profits between subsidiaries in Ireland and the Netherlands with tax havens in the Caribbean as the typical final destination. These tactics achieve even lower tax rates or avoid taxes altogether.

“Despite the tax cuts, Ireland’s revenues from corporate taxes have gone up as a share of GDP because the tax base has grown significantly, in large part from massive inflows of foreign investment. This strategy may be helpful to Ireland, but it erodes the tax bases in other economies,” the authors wrote.

“The global average corporate tax rate was cut from 40% in 1990 to about 25% in 2017, indicating a race to the bottom and pointing to a need for international coordination.”

The authors write that, according to official statistics, Luxembourg, a country of 600 000 people, hosts as much foreign direct investment (FDI) as the United States. Luxembourg’s $4-trillion in FDI comes out to $6.6-million a person. “FDI of this size hardly reflects brick-and-mortar investments in the minuscule Luxembourg economy. So is something amiss with statistics or is there something else at play?”