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Why offshore tax amnesty is unlikely to work

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The Bangladesh Bank has offered a tax amnesty against the return of offshore assets by paying a 7% tax. On July 18, a circular from the Bank of Bangladesh stated that “any form of undisclosed offshore assets can be brought into the country legally through the banking channel between July 1 and June 30, 2023 by paying a fee of 7% “.

In addition, it was reported that it was not necessary to declare the source of the funds to be transferred.

A plausible intention behind the Central Bank’s move could be to combat turmoil in foreign exchange markets resulting from currency scarcity.

However, the initiative is subject to criticism that it could help legitimize illicit funds and ultimately have a chilling effect on honest taxpayers. On the other hand, the initiative can also be seen as a mechanism to encourage emigrants to bring back their financial assets and savings through legal channels.

However, this may not be effective since income earned through legal channels by Bangladeshi nationals in foreign countries may already be transferred to Bangladesh in the form of tax-free remittances. Therefore, Bangladeshis who have overseas income and assets may not find this 7% tax amnesty to be a lucrative incentive.

Given the sudden decline in foreign exchange reserves, it is imperative to stabilize the foreign exchange market as soon as possible, but the options available to policymakers are limited. In light of this, the tax amnesty granted by the government can still be seen as a well-intentioned move. This is a critical concern at present and it is essential to assess its likely effectiveness, as it is by no means certain, ex-ante, that money launderers will be inclined to return their financial resources illicit from abroad.

Prior to the offshore tax amnesty, the government granted tax amnesty to undeclared domestic income on several occasions since independence, but tax revenue through these programs has not increased significantly.

The percentage of income tax collected from domestic sources as a result of the amnesty compared to overall collection was unsatisfactory: 6.81% in 2007-08, then fell to less than 1% in during the 2008-09 and 2009-10 financial years (0.72%). % and 0.70% respectively) (Ahmed 2020).

Given the dismal outcome of the domestic revenue tax amnesty, the outcome of offshore resource tax amnesty initiatives is unlikely to be effective.

Let’s consider a few facts and questions to assess this concern. It is well known that illicit transfers through illegal channels occur in large quantities. It should be obvious that only high-income individuals and companies can take advantage of these opportunities (cf. Alstadseter et al, 2018).

The Global Financial Integrity Report (GFI, 2021) states that funds are illegally transferred across international borders “to evade taxes and/or customs duties, launder the proceeds of crime, circumvent currency controls and conceal profits in offshore bank accounts”.

If these transfers are indeed intended to evade taxes and trade duties, the likelihood of reversing capital outflows through offshore tax amnesty seems low.

It is difficult to estimate the scale of illicit financial flows due to their secretive nature. GFI did this by reviewing the latest international trade data, officially reported by governments to the United Nations, estimating the scale of trade misinvoicing.

GFI calculated “value gaps” occurring in the global trading system by identifying “mismatches between what two countries had reported about their trade with each other”.

The annual average total value gap identified in Bangladesh’s trade is around $8.3 billion between 2009 and 2018, and amounts to around 17% of Bangladesh’s total trade (GFI 2021 report), which also reveals the extent of capital flight each year.

Trade misinvoicing and balance of payments leakage are two channels of illicit financial flows in the developing world. Illicit financial outflows due to trade misinvoicing and balance of payments leakage account for 12-17% of Bangladesh’s total trade from 2005 to 2015, of which trade misinvoicing accounts for about 7-12% of Bangladesh’s total trade ( GFI, 2017).

Therefore, trade misinvoicing is the major component of illicit financial flows in Bangladesh.

In this context, even if the central bank’s ambitious approach to tax amnesty works as intended, and if there is a substantial inflow of foreign currency leading to a significant increase in the foreign exchange reserve, the shortage of reserve will be resolved to some degree in the short-run, but there is unlikely to be any significant long-term effect.

The currency depreciation has been significant, and in a short period of about six months, it has increased the incentive to return funds that have been transferred since the beginning of this year.

However, the current scenario is somewhat different from previous years. For example, if the funds were transferred when the exchange rate was 87 Tk to the US dollar, they could be reduced to 95 Tk in a short time – a high rate of return.

And, if the benefit of the tax amnesty were included, the return would be even higher. Individuals may have an incentive to use the high returns from these short-term capital inflows largely to make long-term investments in unperforming real estate assets in the absence of well-structured investment opportunities.

A thriving “hundi” or edge market makes Bangladesh’s capital account more open than the political regime suggests. This implies that traders can drive the value of the Taka up by dampening market activity and, at some point, drive it back down, by depreciating it.

While such behavior would normally be expected in an open capital account with a floating exchange rate and market competition, the ups and downs would not disrupt the market given the strong monetary and fiscal policies and regulations. However, with weak policies and regulation, this can cause turbulence and generate windfall gains of the type seen recently.

It is high time for the government to resolutely strengthen regulatory control and take tough action against unscrupulous “money changers”. Otherwise, the ability of a relatively small group of traders to cause large swings in the exchange rate can lead to greater disruption in the future. The stock market crashes of 1996 and 2012 should serve as a reminder.


References

Ahmed, Sams Uddin. “Tax Amnesty Systems in Bangladesh: Some Observations.” Cost and Management 48, no. 3 (2020): 35-40.

Alstadsæter, Annette, Niels Johannesen and Gabriel Zucman. “Tax Evasion and Inequality.” American Economic Review 109, no. 6 (2019): 2073-2103.

Integrity, Global Financial. “Illicit Financial Flows to and from Developing Countries: 2005-2014.” Washington, D.C. (2017).

Integrity, Global Financial. “Illicit Trade-Related Financial Flows in 134 Developing Countries 2009-2018.” Global Financial Integrity, (2021).

Tahreen Tahrima Chowdhury is a researcher at the Bangladesh Institute of Development Studies (BIDS)