draining development.pdf - Khazar University

120 Draining Development?As in the case of mispricing, the insights provided by this type of studydepend on how profit shifting is identified. Oxfam (2000) estimates thattax revenue losses arising because of corporate profits shifted out ofdeveloping countries are equal to US$50 billion per year. This number iscalculated as follows. Oxfam multiplies the stock of foreign direct investment(FDI) in developing countries (US$1.2 trillion in 1998, accordingto UNCTAD 1999) by a World Bank estimate for the return on FDI of 16to 18 percent in developing countries. Oxfam argues that the true estimatefor the return on FDI is even higher since the World Bank figuredoes not account for profit shifting activities. Thus, they set the rate ofreturn to 20 percent. Next, the paper assumes an average tax rate of 35percent and thus derives a hypothetical corporate tax payment of aroundUS$85 billion. Since the actual tax payments received are around US$50billion, this leaves a tax gap of US$35 billion according to Oxfam. Oxfamaugments this figure with revenue forgone because of the evasion ofincome from financial assets held abroad, which is estimated at US$15billion. This leads to the estimated tax revenue losses of US$50 billion.This approach raises a number of questions. First, one may questionthe accuracy of the tax gap estimates. An important weakness of thiscalculation is the assumption that, with perfect compliance, all incomefrom FDI would effectively be taxed at a rate of 35 percent. The issue isnot that the average headline corporate tax rate may have been closer to30 percent, as Oxfam (2000) recognizes. The key issue is that thisapproach neglects the existence of tax incentives for corporate investment.In the developing world, these investment incentives play a muchlarger role than they do in developed countries (Klemm 2009; Keen andMansour 2008). Many developing countries use tax incentives, forexample, tax holidays or free economic zones that offer low or zero corporatetaxes, to attract foreign investment. It is controversial whetherthese incentives are efficient from a national or global welfare point ofview (see OECD 2001), but the related revenue impact should be distinguishedfrom the impact of tax avoidance and evasion. Neglecting thisimplies that the revenue losses caused by evasion and avoidance areoverestimated. Moreover, the return on FDI is not identical with the corporatetax base. For instance, if FDI is financed by debt, it cannot beexpected that the contribution of the investment to the corporate tax