Financial Transparency Coalition

On Friday Global Financial Integrity published a report called “Tax Revenue Loss due to Trade Mispricing.”  Trade mispricing is a practice that is neither widely nor well-understood by most of the development community.  Yet according to GFI estimates, the mechanism of trade mispricing moves about $400 billion a year out of developing countries (for a more detailed description, see my blog On Tea and Taxes).

The new paper finds that developing country governments lose about $100 billion a year in tax revenue to the practice of trade mispricing.  This figure represents about 4.4% of the entire developing world’s government revenue.

Admittedly, the economics of the paper are simple and the models are not revolutionary, but the conclusions are based on sound assumptions and the dataset is unique.  The paper takes Global Financial Integrity’s estimates for the trade mispricing component of the measure of illicit financial flows and applies country-specific corporate tax rates to estimate the approximate tax revenue lost by developing country governments due to this practice.  There are empirical limitations to this rather broad approach, but those are enumerated in detail in the report.

In the report, there are tables detailing the amount of tax revenue each developing country loses to trade mispricing, as well as each country’s yearly government revenue and the percent loss those countries experience as a result of that outflow.

In observance of this report, this week I am writing a series of blog posts, which highlight some of the more interesting cases of tax revenue loss.  These posts are meant to contextualize our readers’ understanding of the new report.

Today’s post starts our journey in Central America, with Costa Rica, a beautiful tropical country with three major mountain ranges, a central highland plateau, and lowland beaches along both the Pacific and Atlantic coasts.  Since 1949 Costa Rica has enjoyed the region’s longest period of unbroken democracy and its current president, Óscar Arias, was the recipient of the 1987 Nobel Peace Prize for his efforts to end civil wars that were raging in Central America.  Under the Arias administration, Costa Rica has doubled welfare pensions, increased budget allocations for education by 26% and has substantially improved the country’s road infrastructure.   Yet poverty persists.  The percentage of households in Costa Rica unable to meet their basic needs increased from 14.2% of all households in 1994 to 14.9% in 2006, before falling to 13.4% in 2007.  And despite improvements in health services, public clinics are often poor and there are long waits for medical appointments.

A major structural weakness to Costa Rican development is its domestic public debt, which is defined as the cumulative total of all government borrowings minus repayments. This year, the stock of Costa Rican public debt is estimated to be US$14.69 billion, which is about half of its GDP.  The Economist Intelligence Unit notes that this debt represents Costa Rica’s “main policy failure over the last decade.”

According to the new GFI estimates, Costa Rica loses US$968 million a year in government revenue to trade mispricing, which represents about 22% of the entire yearly government revenue.  According to World Bank data, this number is 20 times what the government received in official development assistance in 2007 (US$52 million) and about half of the entire country’s yearly expenditure on health care (US$2.2 billion). The GFI study furthermore notes that between 2002 and 2006 the country lost a sum total of US$4.84 billion in tax revenue to trade mispricing. Had this tax evading money stayed in the domestic economy and had it been properly taxed, it could have reduced public debt by a third in just five years.

You can read the entire report, “The Implied Tax Revenue Loss from Trade  Mispricing,” online here.  To read the next post in this blog series, Tax Revenue Loss and Education in Thailand, please click here.