The Role of Tax Expenditures in Enabling Illicit Financial Flows

Abstract

The role tax expenditures play in fostering or facilitating illicit financial flows has so far not been studied extensively. We provide an explorative overview of the linkages between tax expenditures and illicit financial flows in both source and recipient countries. In a second step, we focus on three kinds of mechanisms. In source countries we analyse the role of special economic zones and tax expenditures that target the extractive sector. In recipient countries we study the use of patent boxes and related mechanisms to attract intangible assets. Bilateral tax treaties, meanwhile, can act as facilitators of illicit financial flows because they provide legal devices with which to shift profits away from source countries, and add another layer of complexity to the tax system. To address the use and abuse of tax expenditures in this context, the transparency, tax certainty and simplicity of tax systems should be strengthened by any government trying to protect its tax base.