GFI: $410bn illicit flows in or out of Philippines from 1960-2011

February 4, 2014

• Philippine Economy Loses US2.9 Billion in Illicit Financial Outflows from Crime, Corruption, Tax Evasion over 52-Year Period; US7.6 Billion Transferred Illegally into the Philippines
• Smuggling through Trade Misinvoicing Cost Philippine Taxpayers at Least US$23 Billion in Customs Revenue since 1990
• 25% of Value of All Goods Imported into Philippines Goes Unreported to Customs Officials

MANILA, Philippines / WASHINGTON, DC – More than US$410 billion flowed illegally into or out of the Philippines between 1960 and 2011—reducing domestic savings, driving the underground economy, and facilitating crime and corruption—according to a new report to be published Tuesday by Global Financial Integrity (GFI), a Washington DC-based research and advocacy organization.  Over the 52-year period studied, the report finds that the Philippines suffered US$132.9 billion in illicit financial outflows from crime, corruption, and tax evasion, while US$277.6 billion was illegally transferred into the country, predominantly through the misinvoicing of trade transactions.

The study, titled “Illicit Financial Flows to and from the Philippines: A Study in Dynamic Simulation, 1960-2011,” [HTML | PDF – 2.5MB] estimates that the misinvoicing of trade transactions has cheated the Philippine government of at least US$23 billion in lost tax revenue since 1990.

“There is a tremendous amount of money flowing illegally into and out of the Philippines,” said GFI Managing Director Tom Cardamone, an international financial crime expert, who is scheduled to unveil the findings of the report at a public forum Tuesday morning in Manila.  “Illicit outflows drain billions of dollars from the official Philippine economy, money that could otherwise be used to help the nation’s economy grow.  At the same time, the illicit inflow of capital and merchandise is perhaps even more insidious: it fuels crime, grows the underground economy, and costs the government billions of dollars each year in lost customs duties.”

Findings

The study, authored by GFI Chief Economist Dev Kar and GFI Junior Economist Brian LeBlanc, finds that between 1960 and 2011, illicit financial outflows from the Philippines totaled US$132.9 billion while illicit inflows through smuggling amounted to US$277.6 billion.  Thus, over the 52-year time span, cumulative illicit financial flows into and out of the Philippines totaled US$410.5 billion.
The vast majority of money flowing illicitly into and out of the Philippines is through the misinvoicing of trade, rather than through other avenues such as unrecorded wire transfers.

“Of the US$132.9 billion that flowed illicitly out of the archipelago, US$95.2 billion—or roughly 72 percent—was via trade misinvoicing,” noted Dr. Kar, the principal author of the report.  “Still, the dominance of trade misinvoicing as a conduit for illicit flows is even more apparent when examining illicit inflows.  Of the US$277.6 billion in illicit financial inflows over the years, some US$267.8 billion—or approximately 96 percent—is attributable to trade misinvoicing.”

The most methodologically thorough analysis conducted by GFI to date, the report concludes that both illicit financial inflows and illicit financial outflows are harmful to economic growth in the Philippines.

Illicit Outflows

“Illicit outflows drain money from the domestic Philippine economy, they facilitate income tax and customs duties evasion, and they are found to deplete domestic savings,” added Dr. Kar, who served as a Senior Economist at the International Monetary Fund before joining GFI. “Even more troublingly, our study finds that illicit outflows have grown over time—averaging just 2 percent of GDP in the 1970s and 1980s, they jumped to 5 percent of GDP in the first decade of the new millennium.  Unless corrective actions are taken, the economic toll of these illicit flows will continue to grow.”

Illicit Inflows

Notably, the study finds that illicit inflows are perhaps an even bigger drag on the Philippine economy than illicit outflows of capital.  The analysis determines that illicit inflows are not a benefit to the economy as they do not flow into the official economy.  Rather, they bolster the underground economy, which Dr. Kar and Mr. LeBlanc estimate averaged 34.8 percent of GDP from 1960 through 2011, although it receded to 29.7 percent of GDP in 2011, the most recent year for which reliable data is available.

The vast majority of the US$267.8 billion that flowed illicitly into the Philippines from trade misinvoicing is the result of the fraudulent under-invoicing of imports.

“Import under-invoicing is generally driven by a desire to reduce or eliminate the prices paid on customs duties and tariffs,” commented GFI Junior Economist Brian LeBlanc, a co-author of the report.  “This problem is so ubiquitous in the Philippines that, over the past decade, 25 percent of all goods imported into the Philippines—or one out of every four dollars—goes unreported to customs officials.  As tariffs on international trade make up 22 percent of total taxes in the Philippines, such widespread under-invoicing has a severely damaging effect on government revenues.”

Staggering Tax Revenue Loss

The report finds that the Philippine Treasury has lost at least US$19.3 billion since 1990 in tax revenue due to customs duties evasion through import under-invoicing alone.  Combined with an additional US$3.7 billion in income, profits, and capital gains tax revenue lost through export under-invoicing, the Philippine government has lost out on at least US$23 billion in revenue due to trade misinvoicing since 1990.

“Since 2000, illicit financial flows have cheated the Philippine government of, on average, at least US$1.46 billion in tax revenue each year,” noted Mr. LeBlanc.  “To put this in perspective, the US$3.85 billion in lost tax revenue in 2011 was more than twice the size of the fiscal deficit and equal to 95 percent of the total government expenditures on social benefits that year.”

Control of Corruption

Dr. Kar and Mr. LeBlanc further find that total illicit flows in the Philippines correlate very strongly with the World Bank’s Control of Corruption indicator over time.

For comparison, the researchers note that while trade misinvoicing relative to total trade increased by three percent per year in the Philippines between 1960 and 2011, trade misinvoicing declined relative to total trade in South Korea by four percent annually over the same period.  The different experiences of South Korea and the Philippines highlight the role of governance, which deteriorated significantly in the Philippines and strengthened considerably in South Korea over the period studied.

Methodology

The study is the most methodologically rigorous analysis of illicit financial flows produced by GFI to date.  Dr. Kar and Mr. LeBlanc developed robust economic models that highlight the drivers and dynamics of illicit flows in both directions.  Additionally, while GFI’s 2013 annual report on illicit financial flows out of all developing and emerging economies—published in December—was the first of GFI’s studies to include re-exporting data from the Hong Kong Customs and Excise Department, the Philippines case study is the first country-specific analysis by GFI to incorporate the Hong Kong data.

Nevertheless, the economists cautioned that their methodology is very conservative and that there are likely to be more illicit flows through the Philippines that are not captured by the models.

“The estimates provided by our methodology are likely to be extremely conservative as they do not include trade misinvoicing in services, same-invoice trade misinvoicing, hawala transactions, and dealings conducted in bulk cash,” explained Dr. Kar.  “This means that the vast majority of the proceeds of abusive transfer pricing between arms of the same multinational corporation as well as much of the earnings from drug trafficking, human smuggling, and other criminal activities—which are often settled in cash—are not included in these estimates.”

Starting a Dialogue about Illicit Flows

Global Financial Integrity is partnering with the Philippines-based Transparency and Accountability Network (TAN) to launch the report at a high-level public forum followed by a press conference at the Mandarin Oriental Manila Hotel in Makati City on Tuesday, February 4, 2014 at 10am local time.  GFI trusts that the report will help begin a constructive dialogue with the government of the Philippines about measures that can be taken to curtail illicit flows.

“We hope that this study will spur the government of the Philippines to consider effective legislative and regulatory measures to curb the flow of illicit money into and out of the Philippines, thereby maximizing domestic resources for development,” noted GFI’s Managing Director Tom Cardamone, who will be headlining the launch of the report in Manila.  “GFI’s goal is to work constructively in conjunction with government officials to curtail these harmful illicit flows.”

Policy Recommendations

GFI recommends a number of steps the Philippine administration can take to ameliorate the problem of illicit flows of money into and out of the country.  According to the organization:

•   Transactions involving tax haven jurisdictions like Hong Kong, Singapore, and Dubai should be treated with the highest level of scrutiny by customs, tax, and law enforcement officials;

• The Government of the Philippines should require that all banks in the Philippines know the true, human, “beneficial” owner of any account opened in their financial institution. Often banks do not know who owns or controls the accounts in their institution – they might have the name of an anonymous shell company, but they don’t know the person controlling that shell company. Hence, the banks cannot monitor the accounts for money laundering. Requiring knowledge of the beneficial owner is a simple step that would significantly help curtail the problem;
• The Philippine government should significantly clean up and boost its customs enforcement, by training its officers to better detect intentional misinvoicing of trade transactions. Software exists that can assist governments in detecting invoices that fall outside the normal range of prices for a particular good. The Philippines could make use of such software to catch individuals deliberately misinvoicing their trade transactions to launder money.  The government made significant progress on this front in January, when it launched a new portal at data.gov.ph, which publishes detailed trade, customs, and revenue data.  GFI urges the government to continue making progress on this front;
• The Philippines should expand its list of crimes considered predicate offenses for money laundering to include all felonies.  Anti-money laundering legislation adopted last year expanded the list of predicate criminal offenses for money laundering to include bribery, fraud forgeries, terrorism and terrorist financing activities, and misuse of public funds.  This was a laudable measure, but it still falls short of making sure that the proceeds of all criminal felonies are considered underlying crimes for money laundering; and
• The Government of the Philippines should strongly enforce all anti-money laundering laws that are already on the books.

“The government has made some welcome progress over the past year with regards to customs transparency and anti-money laundering legislation,” noted Mr. Cardamone, GFI’s Managing Director.  “We look forward to discussing ways in which the government can build on its momentum to make a lasting difference.”

Global Financial Integrity further recommends that the Philippines use its diplomatic influence bilaterally and in global forums such as the United Nations to increase transparency in the international financial system and curtail the illicit flow of money into and out of the Philippines.  Policies GFI advocates include:

• Addressing the problems posed by anonymous shell companies, foundations, and trusts by requiring confirmation of beneficial ownership in all banking and securities accounts, and demanding that information on the true, human owner of all corporations, trusts, and foundations be disclosed upon formation and be available to law enforcement;
• Requiring country-by-country reporting of sales, profits, and taxes paid (by multinational corporations);
• Requiring the automatic cross-border exchange of tax information on personal and business accounts;
• Harmonizing predicate offenses under anti-money laundering laws across all Financial Action Task Force cooperating countries; and
• Ensuring that the anti-money laundering regulations already on the books are strongly enforced.