Friday, July 24, 2009

Fair-Trade Promises Hide the Reality of Tax Losses

Something sweet seems to be happening in otherwise bitter cocoa markets, as the Guardian tells us: Cadbury’s is going fair-trade; Mars is teaming up with the Rainforest Alliance; and Nestlé supports initiatives by two trade bodies: World Cocoa Foundation and the International Cocoa Initiative. So is cocoa all sweet now?

A short look at cocoanomics tells us that more could be gained by cancelling tax breaks in cocoa manufacturing and looking at trade mispricing at point of exit from West Africa, or entry into Europe and the USA.

Why is cocoa so sensitive? A part of this answer comes from the regions where it’s grown, over 70% comes from West Africa. A recent Global Wittness report 'Hot Chocolate' looks into the rebel financing, not so different from the infamous ‘blood diamonds’. Indeed, since the civil war started cocoa prices have doubled.

The International Labour Organisation (ILO) has for a long time drawn the attention to the use of child labour in cocoa farms, estimated at 200,000 children working in farms. This report led to the establishment of the International Cocoa Protocol, implemented by voluntary codes of conduct at trade bodies like the Association of Swiss Chocolate Manufacturers.

The real problem underpinning cocoa growers is poverty. In Ivory Coast, it’s estimated that only 35% of the world market price is retained by the farmers – some US$ 950 per tonne. In Ghana, the producer price is fixed by the government at GH¢ 1632 (US$ 1090) per tonne, so a typical household producing 3-10 bags (62.5 kg each bag) of cocoa in Ghana will make between US$ 200 - 700 in annual incomes from cocoa.

Fair-trade’s first benefit is that it helps producer villages with a transfer of an additional US$ 150 per tonne, establishing floor prices if prices plummet, and organising farmers in co-operatives and producer associations for better representation and retaining more value-added.

Cadburys buying an additional 10,000 tonnes of fair-trade cocoa (tripling existing fair-trade production in Ghana), means an additional US$ 1.5 million in revenues to village development projects. However fair-trade alone won’t have the capacity alone to lift the farmers from poverty – state funded schools, hospitals and other public services are needed to be paid by government spending.

The monetary benefits are dwarfed by transfer mispricing. A recent study by Christian Aid titled ‘False Profits’ estimated that trade mispricing from cocoa producing regions to West Africa accounted an average total annual loss of US$ 135 million for cocoa and cocoa preparations. The figure is based on deviations from the average world market price, as produce arrives in ports in Europe and the USA.

This is a problem much wider than what is addressed currently by fair-trade initiatives, as it tackles the producer price, but not lost tax revenues at further stages of production. As fair-trade moves mainstream, it will increasingly use conventional commodity trade channels, and the tax issues become ever more relevant. Tax audits should in the future make an integral part of fair-trade monitoring and evaluation excercises -- and guidelines following our country-by-country reporting proposal should be used for this measure.

A separate issue, not illegal but still questionnable, are the extensive tax holidays given to cocoa manufacturing plants in key producing countries. For instance, in Ghana most processing companies establish themselves in Export Processing Zones (EPZ)s or benefit from specific agro-industrial tax exemptions.

In the past two years, both Cargill and Barry Calebout have established large (60,000 and upwards tons of produce) facilities in Ghana, both in the Tema Free Zone. In the free zones, the tax holiday is 10-years, and a 8% rate is applied thereafter. Meanwhile, Archer Daniels Midland will be establishing a facility in Kumasi, benefitting from a 5-year tax holiday on agro-processing industries outside of Accra and Tema. After the initial holiday a 10% rate is applied instead of the statutory 25%. The issue with EPZs is that it’s hard to estimate the costs and benefits of such incentives, questionned by a recent IMF paper.

This is because the current development model is focused on increasing exports, and growth – instead of stronger public finances. This distorts the development priorities, as growth and especially exports per se don't yet tell of the level of development if hefty exemptions and rampant tax evasion is taking place.

What do investors say about Ghana? A UN Millennium Cities Initiative (MCI) report on Kumasi quotes one investor:
"Kumasi’s natural endowment is phenomenal and can provide basic raw materials for many industries. In addition, at present, Ghana provides one of the best investment environments in Africa, with long tax holidays, duty-free entitlements, immigration quotas, and a good chance to do profitable business. Among the areas investors can explore are agriculture, medicinal plants, timber, mining for gold and industrial diamonds, etc.”
Giannetto Caraceni, General Manager, Modern Wood Technology Co. Ltd (p.2)

The free-for-all tax environment is detrimental to development. If this is what the UN Earth Institute promotes as a development model, then count us out!


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2:48 am  

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