United States Department of Defenestration
Washington, DC 20099
To: Henry M. Paulson Jr., Secretary of the Treasury
From: Raymond W. Baker and Jennifer M. Nordin
Re: Dirty Money
Date: September 1, 2006
Riggs Bank’s dealings with corrupt foreign officials, corporate scandals like the collapse of Enron and WorldCom, terrorist financing and failing states all demonstrate the impact of “dirty money” on U.S. economic and national security interests. This memorandum outlines why curtailing dirty money is of vital importance to the United States and specifies eight steps the Treasury Department should take in this direction. Still in the early days of your tenure, Mr. Secretary, this is an issue on which you can make a major difference and ensure your legacy as an effective and influential public servant.
Money that breaks laws, whether because of its illegal origin, movement or use, is “dirty money.” Roughly $1 trillion in dirty money flows across international borders each year. Half of this comes out of developing and transitional economies into U.S. and European accounts. These illicit cross-border transfers are generated by three means:
- Corruption: Government elites who profit from the abuse of their authority and shift funds abroad produce about 3 percent of the global total of “dirty money.”
- Criminality: Proceeds from drug sales, arms trading, racketeering, counterfeiting and a host of other offenses constitute about a third of total cross-border dirty money.
- Illicit commerce: Corporations and individuals generate more than 60 percent of global dirty money by falsifying the pricing of imports and exports, faking transactions, laundering money and other techniques.
Clandestine funds move around the world, and both in and out of our own country, thanks to a comprehensive dirty money structure that has evolved over the past forty years. Components of this system include more than seventy tax havens and offshore secrecy jurisdictions; one to three million disguised corporations worldwide; “flee clauses” that allow disguised corporations to relocate from one secret enclave to another; anonymous trust accounts; fake foundations; false documentation; mispricing in international trade transactions; and loopholes in Western laws that facilitate the movement of proceeds through the dirty money structure into Western financial institutions.
U.S. banks and businesses bear too large a share of responsibility for dirty money, especially those financial institutions that actively solicit deposits from clients and corporations that abuse transfer pricing as a normal part of their international activities. These banks and businesses help the perpetrators of dirty money reach their goal: to get their cash into the legitimate financial system. Our toleration of the dirty money structure as it has grown in recent years guarantees that it will grow still further unless we act now to stop it.
Implications for U.S. Interests
The flow of illicit proceeds undermines U.S. national interests around the world in five basic ways.
The U.S. government cannot have maximum impact on curtailing terrorist financing without stanching the flow of other forms of unlawful funds. Terrorists use the same mechanisms as corrupt businessmen and criminals. Blocking the channels for all dirty money is much more effective than targeting just the terrorist or drug money passing through these channels. The proceeds from any one type of dirty money can and do finance terrorism. The idea that we can pick and choose what dirty money to block and what to accept is a sure recipe for failure in the War on Terror.
Dirty money undermines our efforts against drug trafficking and other global crimes. The endgame for the illicit trade in drugs, arms, humans and counterfeit goods is moving ill-gotten gains into the legitimate financial system. By preventing criminals from shifting their profits into Western accounts, we eliminate a primary motive for their activities. If the financial rewards for global crime decrease, crime will decrease as well.
Dirty money renders U.S. foreign aid less effective. Official development assistance globally totals about $80 billion per year, some $20 billion from the United States. But an estimated $500 billion per year escapes illegally from developing and transitional countries into Western coffers. Clearly, our attempts to improve living standards for people in those countries are more than offset by the flow of dirty money out of poorer countries.
Dirty money has a direct financial impact on Treasury: It reduces tax revenue owed to the U.S. Government. Abusive transfer pricing–deliberately varying prices of exports and imports to shift profits offshore–moves money into tax havens. The rule of law suffers from tax evasion. Paying one’s legally required share of taxes, whether an individual or a company, must be a non-negotiable price of doing business in the United States.
Dirty money affects our ability to spread democracy and market capitalism. It reflects capitalism at its worst. Misguided capitalism weakens democracy, as can be seen in Russia and other transitional economies of the former Soviet Union, in some countries of eastern Europe, in Latin America of late, and in many faltering states in Africa. Enormous disparities between rich and poor do not go unnoticed as citizens watch government and industry elites strip their countries’ assets bare using the dirty money structure. The long-term effectiveness of capitalism relies in part on the belief that it is basically fair, and this goes for global capitalism as well as for national economies. The role of U.S. banks and businesses in shifting illicit proceeds undermines the global rule of law and produces widespread disaffection among billions of people who question whether the system we believe is right for the world is also right for them.
In cooperation with Congress, the IRS and other government agencies, the Treasury Department should take the lead to curtail the flow of dirty money in and out of the United States:
- First, Treasury should strongly support legislation to close loopholes allowing illegal funds generated abroad to arrive legally into the United States. Currently, U.S. law defines some 200 classes of domestic crimes as “predicate offenses” for a money laundering charge. However, only 15 of these classes are applicable if committed outside the United States. These 15 we can prosecute include drug trafficking, crimes of violence, official corruption, bank fraud and certain treaty violations. But U.S. anti-money laundering law does not address the proceeds of racketeering, contraband, handling stolen property, alien smuggling, slave trading, trafficking in women, environmental crimes and a host of other unlawful pursuits if they occur beyond our borders. Maintaining two separate lists of “specified unlawful activities” undercuts our ability to curtail dirty money. A bill sponsored by Senator Charles Grassley (R-IA)–S. 2402, “To improve the prohibitions on money laundering, and for other purposes”–would eliminate such distinctions by broadening the definition of specified unlawful activity to include “any act or activity occurring outside of the United States that would constitute an offense . . . if the act or activity had occurred within the jurisdiction of the United States or any State.” Adopting this into law is the single most effective step we can take toward ending U.S. complicity in the dirty money structure.
- Second, Treasury should lend strong support to the expansion of the Title III anti-money laundering provisions of the USA PATRIOT Act. At present, Section 313 prohibits U.S. financial institutions from receiving money from foreign shell banks, a useful but incomplete provision. This legislation should move beyond shell banks to include disguised corporations, anonymous trusts and fake foundations. No secret commercial entity should be able to do business with the United States.
- Third, Treasury should direct the IRS to require corporations to file reports on all offshore subsidiaries and affiliates, including their names, locations and purposes. In this way, corporations would have to explain and defend the legitimacy of having such entities in tax havens and secrecy jurisdictions, and Treasury could get a far better handle on instruments that facilitate tax evasion.
- Fourth, Treasury should support IRS Commissioner Mark Everson’s call for discussion of whether corporate tax returns should be made public. This is the most important step the U.S. government can take to curtail the erosion of tax revenues from the private sector. There is no good reason why publicly-chartered corporations should not publicly report their tax payments. If they do not do so voluntarily, they should be required to do so by law.
- Fifth, Treasury should work with the Department of Homeland Security to encourage immigration and customs enforcement agencies to require a pricing declaration on commercial invoices for trade transactions. This declaration would be signed by both importer and exporter, stating that there is no violation of income tax laws, customs regulations or money laundering statutes. Falsified pricing is the most frequently used technique for moving illicit commercial proceeds among countries. The power of the signature, as modeled in Sarbanes-Oxley’s requirement that CEOs and CFOs verify periodic accounts, should be brought to bear on this pernicious problem.
- Sixth, Treasury should require U.S. banks and other financial institutions to periodically inform foreign account holders that only incoming transfers that meet all U.S. legal standards are acceptable. The prevailing norm in U.S. banking practice is “don’t ask, don’t tell.” That’s not enough anymore. Foreign account holders likewise should be required to periodically confirm that they will abide by the requirement.
- Seventh, Treasury should require banks to freeze financial account activity for politically exposed persons (PEPs)–i.e., government officials, their family members or others acting on their behalf–while PEPs are in office. This is the best way to avoid aiding corrupt government elites who are stealing from their own countries.
- Eighth, Treasury should get on board with the growing global movement toward automatic government-to-government sharing of tax information, particularly within the Organization for Economic Cooperation and Development (OECD) countries. This will have a major deterrent effect on illicit financial transfers.
Above all, while enacting these eight steps, the Administration should state loud and clear, from the President’s bully pulpit itself, that the United States welcomes money that is legally earned and transferred and that will be legally employed, but it will not be a safe haven for dirty money. The Administration should also encourage other OECD countries to follow suit. Such admonitions will not put the U.S. economy at a disadvantage, just as adopting the Foreign Corrupt Practices Act in 1977, twenty years before the Europeans followed our example, did not have the deleterious economic consequences many predicted. But it did launch the anti-corruption agenda that is advancing worldwide today.
Curtailing dirty money is not rocket science; it is a matter of political will. The United States should take the lead in cleaning up the global financial system, and the Department of the Treasury should take the reins of this vital initiative. If we want other societies to model themselves after us, we’ve got to clean up our own act.
cc: Senator Charles Grassley
Chairman, Senate Finance Committee
Senator Carl Levin
Ranking Member, Permanent Subcommittee on Investigations