Price that poor countries pay for illegal exit of illicit capital from their economies

Nambale MP Chris Okemo (left) and former Kenya Power and Lighting boss Samuel Gichuru are wanted in Jersey over money laundering. When wealthy individuals, public servants, banks and companies manipulate secrecy and bribe public servants in order to maximise, conceal and move personal wealth and profits abroad, they undermine the very integrity code which underpins any form of public association.Photo/FILE
Nambale MP Chris Okemo (left) and former Kenya Power and Lighting boss Samuel Gichuru are wanted in Jersey over money laundering. When wealthy individuals, public servants, banks and companies manipulate secrecy and bribe public servants in order to maximise, conceal and move personal wealth and profits abroad, they undermine the very integrity code which underpins any form of public association.Photo/FILE 

In its annual report of 2008, the UNDP quoted Prof Njuguna Ndung’u, the Governor of the Central Bank of Kenya, as saying during a keynote lecture at the South African Reserve Bank in 2007 that total capital flight from sub-Saharan Africa was fast approaching half a trillion dollars mark – more than twice the size of the continent’s aggregate external liabilities.

“Paradoxically, the accumulation of external liabilities in the region is mirrored by massive outflows of resources in the form of capital flight—the voluntary exit of private residents’ own capital for safe haven away from the continent,” said Prof. Ndungu.

As indicated earlier, the Global Financial Integrity’s conservative estimate of the scale of capital loss from Africa through illicit means alone to be worth $1.8 trillion in 39 years.

This works out to an average of $11 billion per year. The average over the past decade is in the hundreds of billions. A similar study conducted by Prof Simon Pak estimated the cumulative capital flight from Africa to the EU, the US and the UK and Ireland arising from commodity trade to have been $620 billion between the period 2005-2007 or an average of over $200 billion a year -- more than 10 times the total amount Africa received aid over the same period.

This study estimated Kenya’s capital loss over the three-year period (2005-2007) at $200 million -- many times the average amounts the country received in foreign direct investment. In a strange twist, whist African countries are bending backwards to attract aid and foreign investment they are sleep walking into a major financial haemorrhage.


Similarly, Africa has lost huge amounts of money in uncollected tax revenues to the lords of theft, money laundering and obfuscation.
More recently, Africa has woken up to the realisation that the most reliable and dependable source of money to invest in schools, roads, hospitals, energy and keep our democratic institutions running is in fact taxation.

When public officials steal or divert tax revenues to enrich themselves, the society suffers, the poor cannot get social protection and the market cannot be regulated adequately to create the enabling environment for innovations and competition. More so when we lose faith in the tax system it is hard to see how else public services and public infrastructure can be built.

The market may provide some of that but the market is typically suited to supplying to those who can afford or otherwise can only provide tiered services thereby making inequality worse over generations.

When the rich and companies do not pay their fair share of taxes the burden either falls disproportionately on low income people and workers or alternatively, the state’s ability to provide public services and adequate regulation shrinks.

Loss of tax revenues due to illegal concealment and transfer of capital abroad is enormous. A study commissioned by Christian Aid in 2009 entitled “False Profits” see estimated the loss of tax revenues in developing countries to trade mis-invoicing alone in the area of commodities to have been more than $160 billion between 2005-2007.

Kenya is among the top 10 developing countries in terms of size of revenue lost to the EU the US and the UK and Ireland, with more than $54 million in lost revenue. The size of the loss will be even bigger if the study covered Kenya’s trade relations with India, China, Pakistan and the Middle East.

The damages are even greater to democracy and integrity of public and private institutions. Traditionally, the taxation has played a critical role in bridging the relationship between citizens and state.

Besides the Constitution, it is one of the most empowering tools for citizens to demand accountability from the state.

To undermine it is to break this critical relationship which is at the heart of democratic governance.

Wealthy individuals and companies that actively undermine the tax system through aggressive tax planning, tax avoidance and tax evasion indirectly undermine democracy.

Similarly, when wealthy individuals, public servants, banks and companies manipulate secrecy and bribe public servants in order to maximise, conceal and move personal wealth and profits abroad, they undermine the very integrity code which underpins any form of public association.

This is costly to genuine business people as well as public service. Loss of faith in public institutions can have a dangerous effect on peace and stability.

But even more important is the fact that undermining the tax system exacerbates inequalities in society with huge ramifications on society and the political system.

Taxation has traditionally acted as a potent instrument for reducing inequalities in a society through establishment of a progressive regime that taxes the rich more as a proportion of their wealth compared to the poor.

Secondly, increased revenue derived from the greater contribution of the rich when spent on the poor enables the poor to take advantage of opportunities in the future.

The generation and concealment of dirty money to avoid taxes undermine the ability of governments to address inequalities. Inequalities matter to the rich and the poor alike because growing inequalities of certain types can be a source of future conflict.

Some people say that one of the underlying drivers of Kenyan violence in 2008 was the high levels of income inequalities measured both vertically and horizontally (i.e. in relation to social groupings defined by ethnicity religion and geographic space). But we also know that it is harder to reduce poverty in highly unequal societies compared to more egalitarian ones.

Finally, lack of transparency in banking operations and lax regulations were at the heart of global financial crisis when banks succeeded in concealing their sub-prime assets through what the Basel-based Bank for International Settlements (the ‘bank for central banks’) has referred to as the ‘shadow banking system’.

This is the setting-up of banks, bank-like institutions and funds, including hedge funds, private equity operations and structured investment vehicles – major conduits that mainstream investment banks and others use – in jurisdictions (tax havens) outside the main financial centres and outside their regulatory reach.
The aim is to escape the type of regulation that banking activities usually face and to reduce the tax bill – even if most actual activity remains in the financial centre and not in the havens.

One result is greater opacity, keeping the detail of arrangements largely out of sight (and out of mind) of more stringent regulators.

This enables banks and insurance companies to continue to market, and therefore make profit from, worthless derivatives, a practice which finally imploded into the banking crisis of 2008.
Banking secrecy compounds the transparency problem. Previous large-scale corporate bankruptcies – such as those of Enron and WorldCom – exposed nests of hidden transactions and liabilities, primarily located in tax havens.

These structures misled investors about the true value of the companies’ assets and liabilities.

The current wave of bankruptcies is no different. A Christian Aid report, “The Morning after the night Before”, published to explain the financial crisis, noted a situation where during a discussion in parliament in relation to the nationalisation of Northern Rock bank it became clear that the British government – the new owner – did not know either who owned the Rock’s Jersey-based offshore vehicle, Granite, or what, if anything, it was worth.

If this level of secrecy pertains to our banking sector, it dies not merit pointing out the potential danger in terms of banking stability and contingent liabilities that the people of Kenya carry.

What can be done?

While it is clear that the world has lived with the challenges in the financial services sector for decades, effective and lasting solutions remain elusive. This is because addressing these complex problems requires action at both national and international levels where there remains many points of disagreement.

The UNDP’s Least Developed Countries (LDCs) report mentioned earlier contains a list of reform measures that governments can take ranging from tax policy reforms, trade policy reforms, customs reforms, inclusive growth, legal reforms, But as a caveat the report emphasizes that ultimately it is about the integrity of politics and politicians – what is sometimes called political will.

It is, however, a well known fact that political will does not always come voluntarily but from active citizenship exercising pressure, surveillance, watch dog rolls and whistle blowing, providing evidence through research and dialogue.

It is also true that even the best intended public will fail when the institutions they work for do not have the best skilled personnel and the tools including legal backing to detect and punish money laundering practices.

In terms of domestic the following reform measures would help countries such as Kenya make progress in dealing with the flow of dirty money in or out of their borders.

Experience around the globe shows that countries that succeeded in dealing with the flow of illicit money started the journey with reform of the companies and banking codes/laws.

Kenya’s new Constitution aggressively attacks this problem by barring public servants from holding bank accounts abroad.

The danger that remains is the use by public servants of special purpose vehicles and shell companies owned by shell companies all registered in secrecy jurisdictions to conceal their identities and circumvent the Constitution.

To minimise this, the Law must insist on the following: the revelation of beneficiary ownership by natural persons behind companies and even corporate account.

They should reveal the natural persons behind offshore entities that may be partners to the venture or the account and list all subsidiaries associated with the company wherever they may be registered.

Banks should be discouraged from opening anonymous accounts, multiple accounts, special name or numbered accounts, concentration accounts and similar accounts that make it difficult to trace activities and the assets of their holders.

Banking secrecy must be streamlined to address third party confidentiality issues but with full disclosure to tax and relevant national authorities.

There is also the custom side that countries such as the United States have used the price filter model of Prof Simon Pak to curb trade misinvoicing or its adapted versions.

Besides minimising misinvoicing in imports and exports the model can also be adopted to track domestic procurements of the public sector to minimize leakage through inflated pricing.
One channel that is becoming a big revenue leakage risk for countries such as Kenya that are developing into a hub for multi-nationals is transfer pricing.

The Kenya government needs to spend some resources studying the nature and scope of this phenomenon to cut its losses.
A second best solution is to open multiple bilateral information exchange with as many jurisdictions as possible by signing an international agreement for automatic exchange of tax information globally.

In the mean time, Kenya should sign bilateral information exchange agreements with the major tax havens and secrecy jurisdictions including Jersey, Guernsey, the United Kingdom, Cayman Island, Hong Kong, Switzerland, Mauritius, and Luxembourg.

The government must be aggressive in demanding total transparency especially in terms of beneficiary ownership of accounts and companies registered in these jurisdictions whom/which trades and does business with Kenya. The Germans have after all filed a $10 billion claims against Switzerland in tax losses as a result of their nationals shielding their loot utilising the secrecy service of Swiss Banks. The British and the Americans have done the same.

Besides, the Kenyan government should require all transnational companies to publish every year Kenya specific accounts showing the profits or losses they make.

These profits and loss accounts should be verifiable, including procurements that took place via tax havens and secrecy jurisdictions.

In cases such as the Samuel Gichuru and Chris Okemo affair that inspired this series, Kenya should counter-sue Jersey in the international court and the banks holding the alleged corrupt money from the suspects for complicity in corruption and for compensation for hoarding Kenyan tax payer’s money adjusted for inflation.

Kenya can take a leaf from Nigeria which has sued major companies like the German giant Siemens for corruption and have been compensated through out of court settlement.

Internationally, countries must co-operate to implement key reform measures such as establishing new accounting reporting standards that require transnational companies to disaggregate their accounts and report profits on a country by country basis.

The international community could also help by establishing a framework for automatic exchange of information they hold from companies and individuals. Compliance would be evaluated objectively, with sanctions against states that refuse to part with the information.

The current OECD arrangements encouraging countries to enter into bilateral tax information exchange agreements (TIEA) does not suit all countries equally. Big countries like the United States can seek to haul Okemo and Gichuru to Jersey for trial because they have successfully prevailed upon Jersey to supply the relevant information. Kenya is unlikely, on its own with the weight of others, to receive the same treatment from Jersey.

Such an agreement should include a requirement that all banks and other financial institutions collect information, which should be available to the appropriate supervisors or regulators (including tax authorities), on the beneficial owners of all payments made, whether to residents or non-residents, individual and companies.

Going forward
It is , however, worth acknowledging that a momentum has in recent years been growing in this area.

The African Union has, in collaboration with the Economic Commission for Africa, taken up this issue high up the political ladder.

A high level commission on illicit capital flight is about to be announced.

The UNDP is also slowly building interest and capacity in this area aiming to support governments to address this problem. There is a growing civil society movement for tax justice and to fight illicit capital.

Kenya is the seat of the tax Justice Network Africa. An East African coalition on tax is also on the way and the National Tax Payers Association of Kenya is an active member.

There is enough basis of a collation of government, civil society and ethical businesses to pull together to address this dangerous cancer.