Indian government white paper on "black money" is strange

From India's First Post, looking at a new paper on illicit money from the Indian Ministry of Finance:

The IMF study estimated the flight of capital from India during 1971-97 at $ 88 billion, GFI, in its 2010 report, put the total illicit outflows from India at $213.2 billion. This sum, after adjustment for the possible returns earned on these funds (the money is not kept under a mattress), would amount to $462 billion.

The finance ministry’s White Paper pooh-poohs the GFI claim by saying that the estimates are probably too high since they do not take into account “illicit inflows” – the black money that comes back in to earn returns.

The Indian White Paper is here, and the GFI India report is here. But the reasons cited by the First Post for saying that GFI's numbers (which are, as GFI would admit, subject to very large margins of error) are inflated, are bogus. We explained this a while ago following an attack on GFI's numbers by the Oxford Centre for Business taxation (which in our opinion mixes serious academic research with pro-business lobbying, reflecting its funding sources and the way it was founded: see more on that here.) The Oxford study made a similar point to what the Indian finance ministry is saying: that GFI's numbers overstate the figures because they do not take account of illicit inflows back into developing countries, which they suggest should be subtracted from the outflows. But this is totally wrong. Here is the relevant section from our rebuttal of the Oxford study:

What TJN’s colleagues have measured in terms of mispricng is capital flight out of developing countries into secrecy jurisdictions and other locations. What it does not measure is capital flight into developing countries. To illustrate: TJN’s colleagues have measured capital flight out of, say, Congo, and into Switzerland – but have not measured capital flight from Switzerland into Congo. This is not to say that there is not an issue here – there is – but this now brings us to two important points.

First, it is fanciful to think that capital flight into developing countries from tax havens and elsewhere is likely to be anything like as big as capital flight out of developing countries. Even if, say, capital flight into developed countries were, say, 20% of capital flight losses out of developing countries – which seems unlikely (see Richard Murphy’s analysis of this here) - and we were to subtract one from the other, that would be no grounds at all for concluding that there has been a “drastic” overestimation.

In addition to this, how could they possibly come up with “drastically” if they have not measured this themselves – which they haven’t? The use of this -- headline soundbite – word cannot be supported.

Yet the second point is more fundamental. For the researchers have made an elementary yet crucial error. They say we should subtract losses in one direction from tax revenue losses in the other direction – when in fact we should add them.

If a country loses tax revenue from overpriced imports into developing countries and underpriced exports, it does not somehow magically recoup illicit money going in the other direction which suffers losses from, say, flows evading VAT or import duties. No, it loses revenue in that direction too."

Now in fairness to the Indian White Paper, they do make a concession to our argument. But the way they do this is rather odd:

"Illicit inflows have been excluded mainly on the grounds that since illicit flows are unrecorded, they cannot be taxed or utilised directly by the government for economic development. Further, these inflows are themselves driven by illicit activities such as smuggling to evade import duties or value-added tax (VAT) or through over-invoicing of exports. . . By not considering illicit inflows even if the reasons given are valid, it is apparent that the estimate given in GFI’s November 2010 report of a total of US$ 213.2 billion being shifted out of India from 1948 to 2008 appears to be on a higher side. (TJN's emphasis added.)"

One wonders why India's Finance Ministry would stick to its claim that these numbers appear to be on the high side "even if the reasons given [for using that methodology] are valid." Very strange. And in fact, the paper then continues, by saying that GFI's estimates might, after all, be too conservative:

Moreover the GFI (and World Bank) models do not capture significant illicit outflows, such as through:

• Mispricing occurring through trade in services and intangibles as the same are not addressed in IMF Direction of Trade Statistics
• Trade mispricing that occurs within the same invoice through related or unrelated parties
• Smuggling
• Hawala-type swap transactions

And concludes that further research is therefore needed. We can certainly live with that.

Nevertheless, despite its odd parts, the report contains much that is interesting, and we will put it as a permanent item on our 'magnitudes' page.