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A glance on Black economy
November, 19th 2010

Better tax compliance and more effective global oversight can help stop illegal capital flight worth hundreds of billions of dollars.

A new report by Global Financial Integrity estimates that some $462 billion was illicitly taken out of India between 1948 and 2008, at the present value of money. This finding has been released in a season of scams and brings to mind the exaggerated claim made by L.K. Advani on the campaign trail in 2009 that up to $1.4 trillion has been squirrelled away in Swiss banks.

The flight of capital from India has accelerated after the 1991 reforms, a fact that will likely be used by opponents of a liberal economic order to argue that the market economy has been an excuse to loot the nation. Some capital will always leak out, but the Indian government needs to act on several fronts to plug the obvious holes in the tax system and work with other countries to police the offshore tax havens where this money is increasingly being parked.

The new report argues quite convincingly that tax evasion by rich Indians and companies is an important driver of illicit capital outflows. Indian tax rates have dramatically come down but the tax system is riddled with exemptions and other complications.

It is unfortunate that powerful lobbies defeated the original Direct Tax Code while the government sheepishly looked on. A computerized tax information network that will allow the authorities to track payments across the economy has been delayed for too long.

The growth of cross-border investment and trade since 1991 has opened up immense opportunities to fiddle with the value of export and import invoices. A company can illegally take money out of the country by showing lower export value and higher import value. Multinationals have been known to use transfer pricing to move revenue across tax jurisdictions so as to minimize payouts. Better administration is needed for the former and more international cooperation for the latter.

The problem of capital flight has traditionally been represented as the fault of developing countries that imposed capital controls and usurious tax rates. It is actually a two-way street, with the destinations for such money being an integral part of the problem. The developed nations woke up to this fact only after the growth of international terrorism and the lessons from the financial crisis, with the use of tax havens by the shadow banking system to stay beyond the reach of regulators.

Better tax compliance and global oversight are the two best ways to squeeze tax evaders who take money out of the country. That should help reduce the summer pilgrimages by rich Indians and their financial advisors to places such as Zurich, Mauritius and the Cayman Islands.

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