draining development.pdf - Khazar University

Tax Evasion and Tax Avoidance: The Role of International Profit Sharing 113many, which was the country with the highest corporate tax rate inEurope, would have increased by 14 percent if there had been no taxincentives to shift income to other countries.Profit shifting and transactions among unrelated partiesProfit shifting as discussed in the previous section takes place throughtransactions between entities of multinational firms in different countries.If two corporations located in two different countries belong to thesame multinational firm or are controlled by the same interest, it isuncontroversial that transactions between these two firms may be usedto shift profits across borders. However, some authors have argued thattransactions between unrelated firms may also be used to shift profitsacross borders. This is emphasized, in particular, by Raymond Baker(2005) in his book, Capitalism’s Achilles Heel: Dirty Money and How toRenew the Free-Market System. There, he quantifies the yearly illicitfinancial flows out of developing countries through the business sectorat US$500 billion to US$800 billion.Baker’s book provides a breakdown of this number according to differentactivities. The analysis claims that slightly above 60 percent ofthese financial flows are related to legal commercial activities, whereasthe rest is assigned to criminal activity. Baker argues that money earnedon legal commercial activities leaves developing countries through threepotential channels: the mispricing of goods traded between independentparties, the distortion of transfer prices charged on goods traded withina multinational firm, and fake transactions.With respect to mispricing between unrelated parties, Baker bases hisestimate on 550 interviews he conducted with officials from tradingcompanies in 11 economies in the early 1990s: Brazil; France; Germany;Hong Kong SAR, China; India; Italy; the Republic of Korea; the Netherlands;Taiwan, China; the United Kingdom; and the United States.Because Baker assured anonymity, he does not make the data publiclyavailable, but argues that the data contain appropriate information ontrading practices.He reports that the interviewees confirmed that collusion was commonbetween importers and exporters to draw money out of developingcountries. Specifically, he states that “mispricing in order to generatekickbacks into foreign bank accounts was treated as a well-understood