Capital flight from developing countries--what is it, how is it measured, and what have we learned?

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Many worry that developing countries lose a substantial amount of money via capital flight, that is, outflows of cash and securities--part of which can also be illegal. Those funds, if they came into the limelight, could be subject to tax and the revenues could support the financing of important development goals.

Some estimates of capital flight are very large and have attracted a lot of attention by the media, NGOs, and policy makers alike. But are those estimates reliable? And if they are, how do those financial flows compare with other macroeconomic quantities?

In a recent WIDER Working Paper we seek to achieve two main goals. First, we critically review the methods used to measure capital flight--be it a result of individual taxpayers failing to disclose their offshore wealth, or by multinational enterprises using transfer mispricing in their cross-border transactions. Second, we put the findings into context by discussing the implications of the findings for tax and development more broadly.

An estimated 8% of household financial wealth held in tax havens

The most prominent estimates of wealth held by private citizens in tax havens are provided by Zucman (2013, 2015). Drawing on statistics of cross-border portfolio investment, he shows that, globally, reported liabilities exceed reported assets, suggesting that part of the assets are undeclared. The vast majority of the 'missing wealth' is located in a few well-known tax havens --a finding which is highly suggestive of tax evasion. The findings imply that, globally, around 8% of households' financial wealth is held in tax havens. By making assumptions about the rate of return and the tax rates on capital income, the stock of wealth can be turned into estimates of lost tax revenue, which amounts to around US$200 billion annually. The greatest losses accrue to Europe, the US, and Asian countries.

Losses from tax avoidance by multinational companies affect developing countries

Turning to the firm side, researchers have shown how profits reported by multinational companies respond to tax differentials between host and source countries. Multinational companies must value their inputs and intermediate goods when they are moved within the same company across country borders. These prices should reflect the market value of transactions, however, firms may be tempted to deviate from market prices in order to move profits to countries with low tax rates. This phenomenon is known as transfer...

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