Avoiding the curse

Revenues from the oil and mining activity should feed a government’s budget and help finance education, healthcare and infrastructure. When revenues are not spent directly, they should be accumulated in a wealth fund that becomes an endowment to be spent by future generations.

Revenue management is successful if the revenue allocation process fulfills the citizen’s basic needs via the provision of public goods such as education or healthcare. In order to succeed, revenue management should be administered by an administration that shows high levels of transparency and public governance. Transparency is necessary to make sure that each dollar of revenue is monitored and is not lost on its way from the mine to the government via corruption or bribery either at the governmental or the corporate level. Public governance guarantees the appropriate use of the available revenues.

MORE TRANSPARENCY

Corporations

A meeting between campaigners and investors that took place in London in 2008 with representatives of some of the largest mining and oil companies and the International Accounting Standards Board, is likely to persuade the latter to introduce country-by-country reporting that would be adopted as soon as 2010 and help diminish the culture of secrecy and corruption present in some of the mining corporations (Mathiason, 2008).

A piece published by the Tax Justice Network under the name How to make multinational companies more transparent (Murphy, 2008) proposes country-by-country reporting as a way to enforce more accountability of corporations. There is concern that national governments do not profit from skyrocketing commodity prices, and that the upside is mostly allocated to corporations’ shareholders through earnings and dividends. The report emphasizes that although all countries suffer from tax avoidance, poor countries are most vulnerable: “They rarely have the necessary resources and capability to challenge corporations trading in their countries. Poorer countries’ public finances also often depend to a larger degree on corporate taxes than wealthier countries do, so tax avoidance by multinational corporations has proportionately greater impact on them” (Murphy, 2008). Corporations will use three mechanisms to avoid or reduce taxes without breaking the law. These three mechanisms are described by Murphy (2008):

•         Finding and exploiting loopholes in domestic tax laws;

•         Adjusting a company’s accounting to reduce its tax bill;

•         Shifting profits out of a country with a higher tax rate and into a country with a lower tax rate.

The most common way of shifting profits out of a country is by a transfer pricing arrangement, which can apply to the sale of raw materials, including commodities. In a transfer pricing arrangement, two national subsidiaries of a corporation can buy and sell from each other products and raw materials at prices that can be artificially set and do not relate to any market forces of supply and demand.

According to Murphy (2008), the International Accounting Standards Board has the ability to enforce country-by-country reporting that would end the malpractices of tax avoidance. More than 60 percent of world trade takes place within subsidiaries that belong in the same corporation.

In 2008 Transparency International released its Bribe Payers Index. According to the report “Companies based in emerging economic giants, such as China, India and Russia, are perceived to routinely engage in bribery when doing business abroad” (Transparency, 2008). The report ranks the top 25 exporters according to the likelihood that their corporations getting involved in bribery while doing business abroad. The bottom five countries are from best to worst: Brazil, India, Mexico, China and Russia. By regions China, South Africa and India are the worst performers in Africa and the Middle East; Taiwan, South Korea and India are the worst performers in the Asia Pacific region; Spain, Italy and China are the worst performers in Europe and the United States; and Italy, Spain and China are the worst performers in Latin America.

Bribery is organized into three different categories, namely: (a) bribery to high-ranking politicians or political parties; (b) bribery to low-level public officials to speed things up; and (c) use of personal and family relationships in public contracting. The report also classifies bribery by 19 sectors. In the “bribery of public officials”, Oil & Gas and Mining are in the top 5 of the sectors where bribes are most often, and more likely to be, paid.

Reports of this nature are exemplary and essential to understand the scope and repercussion of corruption. Oil, gas and mining are among the sectors where the incidence of bribery is more widespread. Multinationals from China, India and Russia, three emerging economies with a large representation in the oil and mining industries, are most likely to bribe public officials. This raises an additional concern, because China, India and Russia have a large share of the market of multinationals operating in oil, gas and mining.

Governments

Developing countries have historically been less able to raise taxes than developed countries. A state finances the delivery of its public services through public expenditure. Public expenditure is a function of a government’s ability to raise revenue through taxation. In developing countries much of the economy is informal and immune to the taxation efforts of the relevant taxation authority. As a result the government has not much room for maneuver and has to rely on two sources of revenue: (i) tariffs; and (ii) corporate taxes on oil and mining companies. In many resource-rich countries (ii) above is where a majority of taxation revenue comes from. Therefore, the ability to raise taxation revenue from the oil and mining industries, and utilize the revenue appropriately is crucial to success.

APPROPRIATE USE OF TAX REVENUE

Paper Review

In a paper entitled Determinants of tax revenue efforts in developing countries (Gupta, 2007), Abhijit Sen Gupta, an economist at the International Monetary Fund, argues that developing countries will have to contribute more and more to raising funding on their own to finance, among other items, the Millennium Development Goals, because continuing to rely on foreign debt is not sustainable on the long run. Gupta contrasts Botswana’s ability to raise as much as 40 percent of its GDP in taxes with Guatemala’s or Burkina Faso’s 11 percent. Gupta points out that “structural factors such as per capita GDP, share of agriculture in GDP, and trade openness are strong determinants of revenue performance”. He also finds that many Subsaharan African countries perform better than predicted. “Countries like Zimbabwe, Zambia, Burundi and Ethiopia performed better than predicted, whereas countries like Chad and Madagascar fell short of their revenue potential”, argues Gupta. He adds that high-income, resource-rich developing countries such as Botswana, Oman or Kuwait have performed close to their revenue potential. Gupta concludes that “a reduction in corruption and an increase in the overall political stability of a regime are expected to improve revenue performance of low-income and middle-income countries”.

In another study of the efects of economic policies and corruption on tax revenue, Dhaneshwar Ghura (1998) connects declining corruption with the ability to raise tax revenue. In his study of 39 Subsaharan African countries in the period 1985-1996, he concludes that “there is strong evidence that an increase in the level of corruption lowers the tax revenue-GDP ratio; thus, efforts to lower corruption would be expected to increase tax revenue significantly” (Ghura, 1998).

Budget Transparency

Raising tax revenue by reducing corruption is only part of the equation. Utilizing tax revenue appropriately in a way that avoids bribery and allocates a fair share of the funding to the extreme poor is also paramount because it maximizes each dollar’s social return in countries that are in desperate need of basic education and healthcare.

The Open Budget Initiative (OBI) is a project of the Center on Budget and Policy Priorities based in Washington DC. In 2006 OBI issued the first ever Budget Transparency Country Rankings, where countries are classified according to how transparent they are in managing public revenues and reporting public how the tax dollars are spent. The effort, completed by civil society organizations from 59 countries, is the first of its kind and yields interesting results. According to OBI “the index is intended to provide citizens, legislators, and civil society advocates with the comprehensive and practical information needed to gauge a government’s commitment to budget transparency and accountability”.

OBI points out that “The level of budget transparency in a country is strongly influenced by the willingness of the government to be accountable to its citizenry” (Open Budget Initiative, 2006). Open Budget Initiative concludes that “sharp improvements in transparency are possible in short periods with modest resources” (Open Budget Initiative, 2006).

Jaime Pozuelo-Monfort is author of the book The Monfort Plan