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Mispricing in Essex

by Jorma Penttinen (09/07/06)

Near Colchester, the oldest town in England, at the university of Essex the Tax Justice Network held its fourth summer seminar on 6th and 7th July. There is hardly any other place where you can see so many experts on global tax evasion at the same time.

The title of the seminar was ”Tax, poverty and development finance”. Some 60 people (the maximum amount, the organisers put a limit so that discussion could be more intense) of activists, experts and persons from political circles from 15 different countries attended the seminar.

Perhaps the most intersting presentation was given by professor Simon J. Pak who has analysed the foreign trade of the United States for more than ten years. He has himself developed and written a computer program with which he can detect abnormally priced goods from a vast trade database. This, he explained, shows how assets are moved from on country to another.

Two years ago at Essex professor Pak lectured on the trade between the USA and Russia. This year he told facts about the capital flow from African countries through mispricing.

The examples of mispricing he has discovered are astonishing. In one instance, for example, raw cane sugar was imported to the US from U.K: at 1,407 dollars a kilo. Another shipment of same product from the same source country was valued at 50 cents a kilo. Clearly, someone is telling lies to the US customs.

In estimating the annual capital outflow from Africa to the US, professor Pak went through virtually every transaction of goods between Africa and the US as reported in the US trade statistics. After the program detected abnormal pricing the significance of it was, if possible, evaluated. It's important to understand that his study does not reveal if abnormal prices are inside one company – i.e. transfer pricing – or trade between individual agents. Naturally with abnormal prices there must be some relation between an exporter and an importer, otherwise the trade transaction would be utter foolishness for either partner.

There are two sides of mispricing in Africa's foreign trade: low-priced exports and high-priced imports. When someone imported new radial tires from the US to Ghana at a price of nearly 6 000 dollars a piece and the US-World median price for the same product was $188.15 the exporter made a fortune. Why would anyone buy tires that are 32 times more expensive than similar tires elsewhere? Of course, there is a case of asset transfer from Ghana to the US. Whether there was a question of corruption, tax evasion, criminal money, unfortunately professor Pak's study doesn't reveal the reason behind abnormal prices. Vice versa, when someone exports industrial diamonds from Ghana to the US at a price of 43 cents a carat when the US-World median price is $131.94, it is also a question of asset transfer to the US.

After analysing the effect of mispriced imports and exports between Africa and the US for every country and every article, professor Pak ended up with the total annual outflow of capital to the US. In the ten year period 1996-2005 the amount was over £31 billion. The results varied from country to other but larger capital movement was due to low-priced exports than high-priced imports.

One important finding was that capital flight from Africa to the US has more than doubled in the last ten years. Practices vary from one country to another but evidence is nevertheless striking.

Professor Pak is eager to get detailed trade statistics from different countries in order to study abnormal pricing throughout the world. The question for the Nordic countries is what information we would get from using his analysis. One example of the effects of transfer pricing in Europe is the moving of profits to Ireland's low-tax regime. For example in 2004, Microsoft's subsidiary in Ireland called Round Island One Limited had profits of $9 billion, and it paid taxes only for $300 million (effective tax rate little over 3 percent). In the rest of Europe Microsoft paid 17 million dollars.

This kind of transfer pricing would not probably show in professor Pak's analysis because companies like Microsoft, Lidl or IKEA operate with large quantities and narrow price ranges. Therefore even if the prices would not be seen so abnormal, they could effectively move assets from one country to another.

Nevertheless, professor Pak's method gives us totally new information on international trade and Nordic countries' tax authorities should consider using his expertise to unveil hidden practices.