Chapter-I

conceptual Framework­MoneyLaundering and Tax Evasion, Rationale of the Study

Chapter -I

Conceptual Framework - Money Laundering

and Tax Evasion, Rationale of the Study

1.1 Governmental Intervention - .Justification

Since the end of the second world war government intervention,

in Keynesian form or any other, has not only become a fashion but also

inevitable. The present crisis in the US and across the world justifies

this. Two important reasons justify governmental intervention - to

stabilize the economy and to set it on a high growth path and restrict

anti-social activities that act as obstacles to the desired socio-economic

outcome. The intervention can take various forms - from taxation to

running an enterprise; mild or hardcore. But one thing is certain that to

succeed in intervention the government should have at its disposal,

accurate information or data. Absence of accurate data leads to

designing and implementing faulty policies only generating undesirable

results. Many reasons are responsible for the unavailability of correct

information. One such significant cause is the presence of underground

economy in the form of money laundering and tax evasion. It only

guarantees underestimation of many important variables like GDP, per

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capita GDP, GDP growth rates, etc. This is then responsible for faulty

design of our five-year plans, programs and other policies. In this

context, the study of money laundering and tax evasion gains immense

significance. Presence of money laundering and tax evasIOn

significantly increases the social and economic costs of achieving

economic goals.

1.2 Exposed Emerging Markets

Money laundering is a problem not only in the world's major

financial markets and offshore centers, but also for emerging markets.

Indeed, any country integrated into the international financial system is

at risk. As emerging markets open their economies and financial sectors,

they become increasingly viable targets for money laundering activity.

Increased efforts are made by authorities in the major financial

markets and in many offshore fInancial centers to combat money

laundering. This activity provides fUliher incentive for launderers to

shift activities to emerging markets. There is evidence, for example, of

increasing cross-border cash shipments to markets with loose

arrangements for detecting and recording the placement of cash in the

financial system and of growing investment by organized crime groups

in real estate and businesses in emerging markets. Unfortunately, the

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negative impacts of money laundering tend to be magnified in emerging

markets.

A closer examination of some of these negative impacts in both

the micro- and macroeconomic realms helps to explain why money

laundering is such a complex threat, especially in emerging markets.

Only in recent times economic analysis has developed special focus on

monetary issues related to the study of criminal activity which was

absent in the intemational study of economics. The post Keynesian era

shifted the focus from development to the control of economy by

Govemmental interferences as monetary frauds took different forms.

Previously there were few monetary scams or rather the magnitude of

economic crime was considerably low or negligible. As the shift from

welfare economy to capitalist economy increased, the economic crimes

also increased taking into its ambit almost all walks of life. If we take a

global view, it becomes evident that even crime of the organized kind

has a long if not necessarily noble heritage. The word 'thug' dates to

early 13th-century India, when Thugs, or gangs of criminals, roamed

from town to town, looting and pillaging. Smuggling and drug­

trafficking rings are as old as the hills in Asia and Africa, and extant

criminal organizations in Italy and Japan trace their histories back

several centuries. Today, crime is thought of as an urban phenomenon,

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but for most of human history it was the rural world that was crime­

ridden. Pirates, highwaymen and bandits attacked trade routes and

roads, at times severely disrupting commerce, raising costs, insurance

rates and prices to the consumer. According to criminologist Paul

Lunde, "Piracy and banditry were to the pre-industrial world what

organized crime is to modern society. Mafia is a tern1 used to describe a

number of criminal organizations around world. The first organization

to bear the label was the Sicilian Mafla, known to its members as Cosa

Nostra. In the United States, 'the Mafia' generally refers to the Italian­

American Mafia. Other organizations described as mafias include the

Russian Mafia, the Chinese Triads, the Albanian Mafia, the Japanese

Yakuza, the Neapolitan Camorra, the Mexican Mafia, and the French

"Milieu".

In recent years pm1icular emphasis has been focused on the study of Tax

evasion and Money Laundering because of its central role in the

development of any crime that generates revenues. The conduct of any

illegal activity may be subject (0 a special category of transaction costs,

linked to the fact that the use of the relevant revenues increases the

probability of discovery of the crime and therefore incrimination. Those

transaction costs can be minimized through an effective laundering

action, a meaI1S of concealment that separates financial flows from their

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illegal origin. Therefore, from a microeconomic point of view, money

laundering performs a peculiar financial function, responding to the

overall demand for black finance services expressed by individuals or

groups that have committed income-producing crimes. The micro

foundations of money laundering allow us to shed light on its

macroeconomic effects. In fact, if at the micro level the demand should

be matched by an effective supply. The source of illegal money is crime

whether organized or unorganized. There are many criminal activities

out of which illegal money can be generated but so far the economy in

general and the corporate world in particular is concerned, this study is

focused on organized crime that is tax evasion and money laundering.

Before going deep into tax evasion and money laundering, it is

necessary to give a brief idea about organized crime.

1.3 Organized Crime-Definition, Participants, Groups and

Activities

Those that participate in organized cnme are considered to be

involved for the purpose of engagmg in criminal activities on a

sustained basis. Individuals are not acting alone, and the activities that

they are engaged in are not random. In addition, the economic behavior

in mature criminal organizations is intentional and thc activities are

usually directed by identifiable leaders. Tn general, the criminal

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organizations that are of the greatest concem have grown into

substantial enterprises, often with transnational connections that involve

a large number of 'employees' that can range from several hundred to

several thousand.

These cnme groups operate within varymg organizational

structures for a common purpose that is outside the bounds of legal

activity. Although organization is the key to these groups, there are no

standardized pattell1s of structure within groups. A criminal

organization may rely on various features that are best designed to carry

out its purposes. A common feature is a hierarchical, vertically

organized arrangement with fairly tight controls, such as the Colombian

cocaine caIiels. Other types include regionally-structured organizations,

foundations that are quasi-religious or semi-political/military based.

The objectives of the organization ultimately define its

criminality. The type of activities that they are engaged in, normally fall

under the category of what is considered enterprise crime. This would

include the provision of illicit goods and services or goods that have

been acquired through illicit means, such as fraud or theft. One way of

looking at the activities of organized crime would be to compare it to

the fundamental considerations that govem entrepreneurship in the

legitimate market place, namely a necessity to maintain and extend

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one's share of the market. The activities of criminal organizations are

thus equivalent to many of the efforts of legitimate businesses like

export-import, trade in various articles, wholesale and retail sales, and

services. However, the members of criminal organizations seek to

operate in areas outside legal guidelines and will generally trade 111

items also defined as illegal i.e. drugs and weapons.

The scope of criminal activities spans a wide range. Some groups

are highly specialized and only focus on onc type of activity, such as

prostitution or drugs. But, the recent trend is for groups to engage in a

broad array of illegal activities that include both the schemes that have

been at the forefront of traditional organized crime i.e. racketeering and

more recent financial scams that are complex in nature. Whatever the

activity, the underlying purpose is to make a profit from the 'illegal

work' of a large number of people that is coordinated over the time.

Violence is a primary characteristic of organized crime groups,

which is used to promote and protect their interests. Criminal

organizations use violence deliberately by controlling its use and

directing it in specific ways to achieve certain goals. Generally, violence

is used strictly for 'business purposes', although there is sometimes a

lack of discipline or acts of individual cruelty inside organized crime

networks.

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Another feature of organized cnme and related to the use of

violence is the act of bribery. Since they are at odds with police and

other government organizations, organized crime groups will use

bribery in order to corrupt the legal system and evade prosecution.

Large amounts of ready cash provide the incentive to use the power of

money to suborn government officials on a large scale, assisting

organized crime in achieving its objectives.

Organized cnme has many faces. The people who engage in

organized cnme are as varied as the types of organized cnmes they

engage In. There are essentially four categories of organized crime.

They are:

(A) Aboriginal organized crime groups.

(8) Outlaw gangs.

(C) Traditional Italian Mafia crime groups, ethnic groups such as

Asian Triads and Vietnamese gangs.

(0) Colombian cartels and emerging crime groups from Russia

and Nigeria.

Any of these groups could potentially be linked to such illegal

activity like the trafficking of narcotics, extortion, loan-sharking,

various types of frauds, smuggling of cigarettes, alcohol, weapons

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and people (illegal aliens), pornography, prostitution, murder, and

gambling. It is true that any of the groups mentioned in the above

categories could bc involved in any of the crimes just mentioned.

However each catcgory tends to have certain crimes that it commits

with regularity.

In all corners of the globe, organized cnme has permeated

societies, growlllg to such an extent that it IS now treated as an

international security threat. This can be attributed to the decline in

political order, deteriorating economic conditions and expanding

underground economies. Organized crime has ereated an international

environment that encourages people to work outside the legal

framework. FUl1her, difficulties in producing meaningful and effective

state-to-state cooperation are working to the advantage of criminal

organizations. Newly emerging states in political transition, particularly

in central and eastern Europe have provided breeding grounds for

criminal activities where legal principles are loosely enforced. These

factors have contributed to the rise of better organized criminal groups

that are internationally based, and have access to vast financial

resources and a network of other organized crime groups. From this

perspective, organized crime has become a new threat to the stability of

the international system.

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Over time there have been varymg approaches to treating the

plague of organized crime, and because of this, what actually constitutes

'organized crime' has often been misunderstood and is sometimes a

source of controversy. However, a broad consensus has emerged on

several conditions that are required to be met before an illegal activity is

defined as one of organized crime.

Organized crimes also took the shape of white collar crime. The

big business industries involved in the evasion of tax. Who on earth

would like to give to the Government the large amount of money by

way of tax? "The mankind is self centered, egoist and avaricious," says

Plato. The very nature to accumulate wealth by greed led man to evade

legal payment of tax. The money thus saved or earned by way of tax

evasion has created another problem for business and industries and

individuals- that of showing them as legal. To convert their illegal

money into legal, they resort the means available of laundering. But

before money laundering, comes the illegal money. If money are not

earned or accumulated illegally, no question arises of laundering.

Almost all groups, gangs and organizations earn their ill wealth by

conspIcuous means such as drug trafficking, narcotics, human

trafficking, ransom money, loot etc. But side by side there developed a

culture of white collar crimes. The white collar crimes are such crimes

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in which there is no evident criminality. On surface level such crimes

seem not crimes as a layman thinks. They are disguised under the garb

of whiteness. The blackness is covered by the layer of whiteness. There

are many such white collar crimes but the focus of the present research

is on tax evasion and laundering of such money earned by way of tax

evasion. Drug trafficking, human trafficking, terrorist financing are the

problems widely noticed in the developed countries, but tax evasion is

raising its head in the developing countries like India. Tax evasion is the

first rung of the ladder of money laundering. The money earned by way

of tax evasion is being laundered and shifted from developing

economies to the developed economies. This is evident from the

Walker's estimate which shows the shift of money from developing

countries to the developed countries. Tax evasion among other criminal

activities is the first rung of the ladder by which the criminals and the

tax evaders soar up in the sky of prosperity. They very shrewdly conceal

the money earned by illegal means. The evasion of tax in the developing

countries is very high, as is evident from the figures of the detection of

tax evasion. The number of cases detected increases year by year which

is suggestive of the lack of effectiveness of govemment machinery to

bridle the economic crimes. Tables attached in chapter II to this study

will reveal the magnitude of tax evasion both in direct and indirect

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taxation. Before discussing Money laundering it is logical to discuss the

first rung of the menace of money laundering that is tax evasion.

1.4 Tax Evasion and Money Laundering - Rationale ofthe Study

Criminal activities are posmg a threat, which can rum the

economic fabric of the state. Tax evasion and other forms of crime lead

to generation of black income, which in turn leads to black economy; if

allowed to go unchecked, the black economy emerges as a parallel

economy, almost challenging the national economy. By its sheer size

this black economy can throw all macro-economic projections of the

state out of gear; if it is accompanied by capital flight, it can cause

tremendous damage to the economic fabric of the state. Likewise,

economic scams which seem to be occurring with a certain degree of

periodicity in most of the countries of the world, and various other

forms of economic crime, also pose a very serious threat to the

economic well-being of a state.

The crime and criminal enterprises of today also pose a serious

threat to the security of the state. This threat has both an external and

internal dimension; moreover, this threat to national security can be

direct or indirect. Organized crime, which thrives on a nexus between

politicians, bureaucrats and criminals, poses an indirect threat to

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national security by way of internal sabotage. The extent to which

organized crime has developed links with terrorists, for instance in the

case of India, where Inter-Services Intelligence of Pakistan has been

instrumental in forging such links, poses an external direct threat to

national security. Terrorism, a form of low-intensity conflict, generally

stimulated by hostile neighboring countries, poses a direct threat to

internal security; depending upon the way this form of warfare is carried

out, terrorism can have either an internal or an external dimension, or

both.

Another trend that has been noticed worldwide is that these

criminals are branching out into legitimate commercial activities. With

their criminal mindsets and the backup of a criminal enterprise behind

them, thcy pose a very serious threat to legitimate commerce. It is not

uncommon to find criminal enterprises running legitimate businesses to

fund their activities; for example, some of the terrorist organizations

also run legitimate businesses to finance their activities. Organized

crime needs a simulation of legitimacy to operate with impunity; it

acquires this by entering into legitimate commercial activity. Organized

crime groups are also entering into legitimate commercial activity to

maximize their profits. Sometimes this craving for legitimacy can by

itself be an overriding reason for criminals to enter into legitimate

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commerce, in the hope that in three to four generations the family will

emerge as a 'pure business house'; perhaps it is for this reason that one

often comes across the saying, 'behind every fortune there is a crime'.

Since the demise of communism in the early 1990s, most of the

erstwhile Communist states have embarked on the path of economic

liberalization. Even the developing states, which were tinkering with

socialism and planned economies, have taken a similar route. Economic

liberalization not only entails the opening up of the economy, but also

results in greater integration of a country's financial and banking system

with the international financial and banking system. In such a state of

transition from one economic system to another, states are patiicularly

vulnerable to the manipulation of criminals. One example is the role

played by organized-crime groups in Russia. Disinvestments, which was

one of the main planks of economic liberalization in Russia, was so

manipulated by the organized crime groups that what took place was

more or less plundering of state-owned assets. Likewise, in many of the

developing economies, some sectors of the economy became more

active as a result of economic liberalization. In these active sectors, due

to lack of vigilance, the criminals have been at work, the two scams of

major proportions to hit the Indian stock market in the last ten years are

the examples for the same.

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Crime today also has to contend with the revolutionary

developments that have marked the emergence of the information

technology (IT) sector. The reach, the speed and the ease of

communication afforded by the IT sector have blurred the national

boundaries; things are so amorphous that it is sometimes almost

impossible to identity jurisdictions in cases of cyber crime. New and

strange types of crime are also surfacing in the IT sector, because of its

newness. Moreover, the IT environment deals with virtual documents

produced electronically. and the laws of evidence are not geared to deal

with such a situation. The IT sector has led to the emergence of virtual

jurisdictions, also known as cyberspace. So long as criminals are

operating out of conventional jurisdictions, one can still deal with them,

but once they go into cyberspace, they are without traditional forms of

control.

Crime also has to be viewed in the context of some of the global

trends, also described as globalization. One such trend is the growth of

mega-corporations, resulting from mergers of existing multinational

corporations; it is anticipated that these mega-corporations could

become so powerful that even states would not be able to combat their

actions. Another global trend is an attempt to provide 24-hour seamless

trading, through the merger of stock exchanges of different countries.

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Considering the way people travel nowadays for business or tourism,

the world seems like a global village. All of the above global trends,

coupled with many others, afford tremendous opportunity to criminals

of today in fact; all forms of transnational criminality could thrive in

such an environment.

If physics and chemistry were the great sciences of the twentieth

century, then biotechnology and psychology are going to be the great

sciences of the twenty first century. Both of these sciences have the

potential to open up a Pandora's Box in the criminal sphere. The

opportunities that biotechnology could afford to criminals came across

in a very stark manner in a film, wherein human clones were used to

create a deliberate mix-up of identities in the commission of crimes. At

the beginning of the twentieth century, Shri Aurbindo, a great mystic,

remarked that we are living in the Stone Age of psychology; since then,

tremendous advances have been made in the exploration of the human

mind. These advances are likely to produce situations where mind

control could be employed by criminals for their illicit ends.

The various types of crime with the attributes described above on

which one could focus are organized crime, terrorism, trafficking in

small anns, drug trafficking, bribery and corruption, smuggling of gold,

diamonds, economic scams, international economic crimes, tax evasion,

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black economy, trafficking of women, immigrants, antiques, other

forms of smuggling, credit-card frauds, counterfeiting of goods and

counterfeiting of currency, It is evident that diversification and

increased sophistication are two important trends of crime today, The

various types of crimes which I propose to deal with in the context of

this work are organized crime, i.e. tax evasion or black economy.

One of the greatest concerns of criminals today is to legitimize

the proceeds of crime - the process also called money laundering,

According to World Bank estimates, money laundering today is an

US$800 billion to US$! trillion problem. According to the Managing

Director of the Internatio\lal Monetary Fund in his address to the

Financial Action Task Force (FATF) in 1 989, 'money laundering'

constitutes 2 per cent to 5 per cent of the world Gross Domestic Product

(GDP). In recognition of the gravity of the problem posed by money

laundering and in order to deprive the criminals of their illegal proceeds,

thereby hitting them where it hurts them most, money laundering has

recently been categorized as a crime in the criminal laws of several

countries. In the context of this book, the money laundering dimension,

along with national security and economic liberalization, is a major

aspect and therefore, will bc dealt with in all of its ramifications.

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If one takes into account the various costs that the society has to

pay for insurance, for the Government, the health expenditures to treat

drug addicts, the legal system, the judge, the lawyers, the costs of

prison, the social consequences such as dismantling the family, lower

level of education, environmental damages in third world countries that

destroy forests for drug cultivation, corruption and other dangers take

the priority. Drug addicts tend to be deeply involved in criminal

activities leading to higher rate of criminality in society. The costs of

crime related to money laundering are certainly higher than the

estimated, so one can also conclude that additional crime is costly both

for Government and society.

To combat CrImes, states have devised laws - penal codcs or

special laws - on the basis of which enforcement agencies, based upon

their investigations. charge the criminals to face trial. In general, the law

enforcement machinery is lagging behind criminals and the crimes they

commit, in the sense that criminals not bound by any constraints are

generally a step ahead, and the new types of crimes they commit have

not been criminalized by the state concerned. Moreover, it has been

noted that often the criminals escape with a rap on the knuckles by way

of punishment. Inadequate punishments are generally the norm in cases

of white-collar crimes and economic crimes; even though they cause

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much more damage to society than 'conventional' cnmes. Another

noteworthy feature of the criminal justice system that needs to be

highlighted is the cost-benefit analysis of the cost involved In

investigation and trial of criminals and the amount confiscated as 'the

proceeds of crime'. It is the experience that, whereas the cost of

administering justice runs into millions of dollars, especially in cases of

money laundering, drug trafficking, terrorism and organized crime, the

proceeds confiscated are 'peanuts'. From the above discussion, one

inescapable conclusion that emerges is that national responses have not

been adequate to deal with modern-day serious crime.

Grave and serious crimes such as ten-orism, narcotics trafficking,

organized crime and money laundering, which are also transnational in

character, have been engaging the attention of the 'comity of nations'­

Several international conventions have been promulgated to deal with

them. Although conventions to deal with narcotics trafficking and some

forms of ten-orism, such as hijacking, have existed for some time, the

latest in the series of such conventions is the United Nations Convention

against Transnational Organized Crime. This covers organized crime,

money laundering and corruption, and the protocols annexed to it cover

trafficking in arms and in human beings (women and children, and

immigrants/laborers). Likewise, at regional and bilateral level too, simi-

19

lar conventions or agreements have been concluded to deal with serious

crime. Although the above conventions or agreements have been able to

focus world attention on the issue of serious criminality, their impact in

combating the same can once again be termed as inadequate.

Upon the nature of the crime, suitable intelligence modules could

now easily be worked out for effective disruptive action. This chapter

would be incomplete if it did not touch upon good governance in the

context of crime. It is the decline in the standards of governance over

the last two or three decades that has resulted in a breakdown of the

state machinery in several areas, including that of combating crime.

This lack of good governance can be ascribed to greed, corruption,

nepotism, erosion of value systems and a general decline in

administrative capabilities. To tackle crimes of today effectively,

restoration of good governance can be said to be a sine qua non.

At this stage, one may well ask what the future portends vis a vis

the fight against crime. Are the prospects for the future optimistic or

bleak? Will it always be a losing battle, and will one always be left to

seek solace in the oft-repeated statement that 'at the end of the day it is

not always the good guys who win'? Arc we to assume that human

endeavor is not sufficient to deal with this problem? Do we have to pray

for a messiah to come and set things right? I, for one, am a firm believer

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in the dictum that one should constantly strive to do one's duty in the

best possible manner, whether it be in the area of combating crime or

other spheres of human activity, and always to hope for the best.

To understand, explain and get solution for combating Money

Laundering activity, one should be aware of the existence of crime in

civil society. Present day terrorism and organized crime are perhaps the

two crimes which seem to pose the maximum threat to a civil society. I

attempt to highlight the environment, in which they occur, the sectors

from which they get generated in economy. Illegal activities can include

both, civil and criminal offences. An offence that is illegal is not

necessarily criminal. For example, gambling is an illegal activity in an

unlicensed casino but it is not a criminal offence. One could focus on

various types of organized crimes such as terrorism, arms trafficking,

drug trafficking, bribery, corruption, prostitution, smuggling of Gold /

Diamonds, economic scams - woman trafficking, credit and swindling,

counterfeiting of goods and currency and tax evasion. It is evident that

diversification and increased sophistication are two important trends of

crime today. To reconfirm, the present study concentrates only on tax

evasion / black money only. Thus, at the very outset what black money

is, what its constituents are and what the various other terms associated

with it should be classified.

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