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Tax Dodging, Aid, and Afghanistan

This post is longer than my usual, so here’s the summary:

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  • The UN and donors grants ridiculous carte blanche tax breaks to its contractors and sub-contractors
  • In the case of the UN, the 1946 Convention which allegedly allows this, doesn’t, making it illegal.
  • As a result, the donors end up subsidizing tax breaks for international businesses.
  • The Afghan Finance Minister is fighting back, against US contractors. We wish him well.

Three or four years ago I found myself in the office of a mid-level UN apparatchik in Monrovia, Liberia.  Even though this particular staffer was Sri Lankan, he had turned his air conditioner down to somewhere around “Northern Saskatchewan” and I could almost see my breath.  In hindsight, I think this was a clever gambit on his part. He was an administrator, forced to spend his day fending off supplicant staff begging for him to actually do his job. The icy temperature in his office made sure they didn’t linger.  Sadly, I had no choice but to linger.

The problem was taxes.  I was trying to trace all the local spending of that UN mission (at the request of UN HQ in New York), and needed to figure out how much local procurement spending was going to the Liberian government through taxes. In other words, if the UN paid a local company $1m for construction materials, how much went to taxes?  My friendly host, the only man in Liberia wearing a wool sweater, assured me the answer was zero. Not a dime. Nada. Bupkis. Zilch.

Why? “The 1946 Convention on the Privileges and Immunities of the United Nations expressly forbids it.  Now go away”

I heard this answer dozens of times, from UN staff in New York and the field. The UN and its contractors do not pay taxes. The Convention forbids it. Now go away.

But it’s not just UN contractors. It’s also its sub-contractors, and its sub-sub-contractors. In one mission (Kosovo, I’m looking at you) we counted that 5 levels of sub contracts were not paying taxes.  That meant that:

  1. To rebuild an office, UNMIK hired a British engineering firm to rebuild an office, which did not pay taxes to the Kosovar government.
  2. To supervise the work, the engineering firm hired an Austrian construction company, which did not pay taxes to the Kosovar government.
  3. To refurbish the roof, the local construction company hired a local carpenter, who did not pay taxes to the Kosovar government.
  4. To purchase his roofing tiles, the carpenter paid a local hardware store, who did not pay sales tax to the Kosovar government.
  5. To import the tiles, the hardware store used a Greek wholesaler, who did not pay import duties to the Kosovar government.

Why is this insane? The UN is effectively shooting itself in the foot here. It’s charged with restoring stability and helping the local government become self-sufficient. But it is ensuring that local government doesn’t get a dime from taxation. As a result, the local government can’t generate enough revenue to meet its obligations (such as paying policemen or building schools) and must turn to the donors, who reluctantly hand over “budget support” grants.

So, effectively, by granting tax-exempt status to anyone who does business with anyone who does business (and so on and so on) with the UN, the donor nations are simply providing subsidies to the companies that work in aid and peacekeeping. Nice little racket, huh?

And it’s actually a big racket. It happens in every UN mission, in Afghanistan, Timor Leste, Haiti, Solomon Islands, etc.  And it’s not just the UN, the big donors like USAID claim similar privileges. In some of these places, the aid or peacekeeping budget is often larger than the entire GDP of the host economy. Imagine if this tax-exempt status didn’t apply to UN contractors? Hundreds of millions of dollars would not only go into the local economy, it would go into the coffers of the struggling local governments. And as an added bonus, donors could spend that money somewhere else.

But here is the really, truly, insane part. The 1946 convention actually doesn’t say that:

That’s pretty much it. Nothing in there about UN contractors, or sub-contractors, or sub-sub-contractors, making the whole tax dodge illegal. So how did this happen? One UN official explained to me “It’s just custom. Some UN official in the 50s decided it included contractors and no one in the local government knew better. When the next mission went up, they pointed to this precedent. And presto, millions and millions of local tax dollars disappear due to the UN’s fraudulent application of an imaginary privilege.”

I know from experience that some local governments have tried to fight back when the UN’s “Status of Mission Agreement” (SOMA) is negotiated at the start of the deployment. But think of the usual circumstances: The whole reason the UN is there is because there’s no government or the local authorities are so decimated by the previous conflict they can’t govern. So basically, no one is minding the shop and the UN walks in and helps itself (or its contractors) to a nice juicy tax free status.

But here’s a ray of hope, in Afghanistan the government is seeking to bust a similar loophole being enjoyed by US government contractors.

This is causing considerable tension between the Afghan government and the US, but also within the US Embassy. Some staff are charged with helping to stand-up the Afghan government and build its tax base. Other staff are there to defend US companies and help them avoid taxes. Makes for some interesting chat at the water cooler.

PDT's "Hero of the Day": Afghan Finance Minister Omar Zakhilwal

I’m rooting for good ol’ Afghan Finance Minister Omar Zakhilwal on this one.  It’s about time someone put an end to this tax dodging.

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6 Comments

  1. RJS says:

    Just becasue the UN doesn’t expressly prohibit taxing staff/contractors doesn’t mean that it should be done. The fact that salaries aren’t taxed may add to the incentive for high quality people to go to developing nations and conflict zones to do their work. And it may reduce the cost of projects, allowing the money to be spent more effectively and on more programs.

    Tax a company, and some of that cost will be transferred to the consumer, or in this case, the UN and other donor, which also means that they can do less on the ground for the people they’re trying help, as oppossed to some government bureaucrat, who lets face it, is likely corrupt and isn’t doing much.

    Your claim that the UN “is ensuring that local government doesn’t get a dime from taxation” is false and unsupported by evidence. Money spent gets circulated in the economy which later gets taxed. The government will generate revenue on it, though just not on the initial infusion. Futhermore who is to say that taxation money will be better spent by the government than by the donor or implementor? The whole reason aid is “tied” in various way is to ensure it is spent appropriately.

    Finally, if it a government cannot meet it’s spending obligations, perhaps the problem lies with the level of those obligations, as opposed to a foreign organization that comes into help and spends money and provides other services without renumeration.

  2. RJS says:

    Of course, aid is sometimes tied to support donor nation economic interests. Making sure it is spent appropriately is another reason.

  3. Matthew Ramsden says:

    What about expenses incurred in non-mission scenarios? Does a contractor who fixes the roof on a UN building in Geneva pay taxes on the income? That would seem to be as fully covered (or not) by Section 7 above as money spent on a mission.

  4. [...] Tax doding, aid, and Afghanistan. Scott Gilmore describes how the UN, USAID contractors, and others avoid taxation in countries where they operate. Instead, donors end up giving general budget support to the host country. But this doesn’t adequately make up for the lost tax revenue, because the tax exemption undercuts the development of a transparent and efficient tax administration system. This has implications for the government’s institutional growth and accountability. [...]

  5. La’o Hamutuk raised this issue a decade ago in Timor-Leste, see
    http://www.laohamutuk.org/Bulletin/2001/Apr/bulletinv2n1b.html#Taxes and the editorial in the same Bulletin, as well as
    http://www.laohamutuk.org/misc/02news.html

    Plus ca change, …

  6. Scott Gilmore says:

    Charles,

    I remember. In fact, it was that bulletin that first revealed the issue to me. If I remember correctly, there were also a few people in the Min Finance (Carnahan? Francino?) who were also aghast at the implications for Timorese revenue.


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