Photo

From 2003 to 2012, $6.6 trillion was secretly and illegally funneled out of developing and emerging economies by entities that may have been involved in crime, corruption and tax evasion, according to a new report by Global Financial Integrity, a nonprofit economic analysis and policy advisory organization based in Washington.

Photo

Nearly 80 percent of that money was transferred through fraudulent trade invoices, falsifying the value of trade deals, making it possible for the funds to illicitly leave one country and move offshore, the report said. The huge outflows are a major problem for poor and middle-income economies. In 2012 alone, there were $991.2 billion in illicit financial flows. The biggest amounts left China, Russia, Mexico and India.

Raymond W. Baker, the president of Global Financial Integrity and an authority on money laundering and corruption, discussed the situation in China:

Q.

How were you able to estimate that about $991.2 billion in illicit financial flows left developing economies in 2012, with $125 billion of that figure coming out of China alone?



A.

We do these annually, using balance of payments statistics and direction of trade statistics. We base our data on what is filed by governments with the International Monetary Fund. We look for gaps in the data. Except for minor entry errors, these gaps are unrecorded financial flows. We look at bilateral data. Does it match? We know our figures are conservative because there’s a lot we don’t cover, like cash and some forms of trade misinvoicing. We didn’t include, for example, any of the trade in services or intangibles. And if the misinvoicing was agreed upon by buyer and seller, that is not included either.

Q.

Is the bulk of the problem in China related to intentionally falsified trade invoices, whereby companies inflate or deflate the price on goods being imported or exported?

A.

Yes. For years we’ve seen the misinvoicing of trade as the preferred method of shifting money abroad. This is not a problem that plagues just China. Western and Chinese companies have used this mechanism, this type of fraud, for tax and other reasons, to engage in abusive transfer pricing.

Q.

Which trading categories are perpetrators of such fraud in China likely to be using?

A.

We have not done a detailed study of this, but the most specialized product categories — where there isn’t a well-known world market price — are the most common. Also, even commodities where there is a world price, misinvoicing by 5 or 10 percent could easily go unnoticed. In specialized machines or software, it’s easy to misinvoice by 100 percent.

Q.

Why are some of the illicit financial flows coming out of China then returning in what you call “round trips”?

A.

This is partly related to China’s rules on foreign direct investment. There are advantages in being a foreign entity — on dividend payments, interest of loans, etc. One reason to create a foreign entity is not just for trade misinvoicing, but to create a seemingly legal channel to keep sending money abroad.

Q.

Is the problem of illicit financial flows caused by flaws in the global trading system? Is there something wrong with the way in which trade is monitored or regulated?

A.

We have stressed the value of free trade. I’m all for free trade — I made my living importing and exporting goods around the world for decades. But we haven’t stressed the value of legitimate trade. There is far too much misuse of trade, trade fraud. The World Trade Organization’s regulations, and the regulations of many countries, state that the price of an item is what is listed on the invoice. That is its value, and revenue authorities don’t often check to see if stated values are out of line.

Q.

Why haven’t we heard much from the United States authorities about illicit money entering or exiting the country, from China or elsewhere?

A.

The U.S. is not doing a lot on this issue. But there are now concerns about terrorist financing that have helped put this issue on the table. And corrupt government officials can do this too. So there’s more and more interest in it. A lot of this money flows through offshore accounts. China has a relationship with the British Virgin Islands, India with Mauritius, Russia with Cyprus.

When money flows out illicitly, countries lose tax revenue and investment revenue. What would happen if the money never left? Some of it would be tax revenue. Some would remain in the economy as investment, consumption and savings. There is the collection of taxes and the multiplier effect of the money. That is what is being lost.

Q.

Apparently, these are not just small companies engaged in this type of behavior?

A.

Many multinationals use misinvoicing on some product at some time. This is the business of tax planning for multinationals. There are imports and exports from subsidiaries. Companies show no profit in some countries and enormous profits in other countries, where taxes are lower. You can do this by what is called abusive transfer pricing. This is pricing export and import transactions between subsidiaries in order to shift money across borders.

One of the most egregious loopholes in U.S. law allows for the incorporation of anonymous companies, where not even law enforcement can figure out who’s behind the entity. These companies are get-out-of-jail-free cards to criminals, terrorists and tax evaders. There are millions of these entities around the country and Congress has done nothing to rectify the problem. Just this week, the European Union agreed to end anonymous companies in Europe. Congress should do the same.