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The case for taxing hawala

October 3, 2011

Problem/Issue:

1)  Hawala, the traditional Islamic method of transferring money, plays a key role in financing major terrorist activity.  A)  The 9/11 Commission found that Al Qaeda relied on a trusted network of a dozen hawala dealers leading up to the terrorist attacks of Sept. 11, 2001.  B)  Hawala finances terror in South Asia.  The lethal Lashkar-e-Taiba terrorist organization uses hawala and Italian hawaladars may have helped fund the 26/11 attacks against Mumbai, India.  C) The late ambassador Richard Holbrooke disclosed that hawala funds the Taliban.

2)  Hawala’s lack of transparency or an audit trail imposes risks to customers and markets.  Since hawaladars (hawala dealers) often operate outside formal financial rules, their records are subject to less scrutiny, and they do not practice know-your-customer requirements.

3)  Even when practiced legally with the best of intentions by immigrants to send the money home to family in their country of origin, hawala enables a massive transfer of wealth to locations with hostilities toward the United States such as Osama bin Laden’s long-time host, Pakistan.  When Mexican immigrants use Western Union, at least they are using an American company with American employees exercising industry standard controls on wire transfers to a country that is not our sworn enemy.

When a Muslim immigrant seeks the services of a black market hawaladar who doesn’t demand proper customer identification, allows the money to be transferred to a high-risk country, and may only keep a paper log of the transaction, it’s a far different scenario.

Options

Regulatory

Many experts and lawmakers have attempted to regulate hawala by forcing hawaladars to register their business with or become licensed by the government.

Effectiveness

In the U.S., hawaladars are required to register as money services businesses (MSBs) with FinCEN.  A publication from George Mason University indicates that only 17 percent of U.S. hawaladars have actually registered.  From a compliance standpoint, the current system is not working.

Ten years after 9/11, MoneyLaundering.com reported that “The number of hawala brokers in the country remains a guess at best. While FinCEN lists more than 42,000 registered MSBs on its Web site, the number of unregistered MSBs, including hawala operations, is close to 160,000, according to a 1997 estimate by a third-party consultant commissioned by FinCEN.”

Moreover, the registration of hawaladars isn’t shedding much light on nefarious hawala transactions.  Even after the examples of 9/11 and the Mumbai attacks, the Times Square bomber was still able to receive $12,000 for his failed attack through hawala brokers.

Keeping hawala proceeds out of the U.S. financial system has proved challenging as well.  U.S. banks have allowed deposits by Afghan customers who obtained their money from hawala.

International efforts to force hawala businesses to register or become licensed have had limited success.  The United Arab Emirates, which is supposedly the hawala capital of the world, requires registration, but only 184 hawaladars have registered.

Political feasibility

The one positive thing to be said for the regulatory approach is that it is politically feasible.  In the U.S., both Republicans and Democrats can and have agreed on the need to bring hawala into the formal economy and subject it to some of the same requirements imposed on banks, currency exchange houses, and casinos by the Bank Secrecy Act and Patriot Act.

Enforcement

Enforcement is difficult since auditors cannot audit what they cannot see.  But if regulation is the only approach that lawmakers can agree to, more rigorous enforcement is required.

The feds at least know the hawaladars that have registered as MSBs.  Regulators and law enforcement should take that a step further by identifying the biggest, worst hawala offender in terms of who has turned a blind eye or even encouraged customers who use hawala for terrorist financing or money laundering.  Get a warrant, raid the office, seize and audit the paper records, arrest and prosecute the hawala boss, and make a very public example of the story to other hawala operators.  This would put hawaladars on notice in a similar way that the Holy Land Foundation conviction put terrorist-funding Islamic charities on notice.

Outlaw

Due to its integral role in terrorist financing, a strong case can be made for banning hawala from the United States altogether.  The U.S. remains, despite its recent recession and credit downgrading, the world’s top-shelf, modern economy.  In the midst of highly documented, closely regulated, computerized banking systems processing thousands upon thousands of accurate transactions per day, the backwards, opaque, dangerous hawala system has little place.

However, making a law against something isn’t always the best way to reduce its prevalence (such as alcohol during Prohibition).  Hawala is illegal in India and nearly so in Pakistan.  Some good that’s done.  Hawala scandals seem to erupt weekly in Indian media, and hawala continues funding militants and worsening the situation in Kashmir.

Politically it’s not feasible to achieve a hawala ban at the U.S. national political level at this time, although state governments (such as Oklahoma, Tennessee, and other states with anti-sharia law movements) could be potential locations that would at least consider a hawala ban.

Hawala transaction tax

An alternative to stiffer regulation or an outright ban would be a remittance surcharge or a financial transaction tax (FTT) on hawala transactions.  The tax could be a fixed fee or a set percentage of the amount of money transferred.  The charge would be added to the amount of money to be transferred as with any sales tax on the purchase of basic consumer goods.  The hawaladar would be responsible for charging the tax to customers, and filing monthly or quarterly tax returns, and paying the taxes collected to the government.

The purpose of the tax would be 1) to begin documenting the notoriously cryptic hawaladars, their money transfer volume, and other pertinent details about their businesses, 2) to recover some of the costs of increased security and financial measures due partly to the problems created by hawala, 3) to retain some of the money that is being rapidly sucked out of the American economy through remittances to far-flung nations like Pakistan.

A federal tax would put hawala within the purview of the IRS.  There are few agencies any of us would rather hear from less, which makes it the perfect agency for hawaladars to hear from.  If effectively applied, a hawala tax could yield millions in revenues for the federal government.  However, Washington’s tax-and-spenders shouldn’t get used to this revenue stream, as brokers leave the hawala business over time.

Politically, Congress may lack the will to adopt such an innovative concept.  The current president is unlikely to sign any bill into law that would offend Muslims in America.  But an enterprising legislator could still draft a bill and start gaining co-sponsors over time.  This is a concept that could unite conservatives concerned about terrorist financing and possibly pick up support from a few pro-tax New York Democrats.  Many Democrats such as Nancy Pelosi are on the record as supporting a generic FTT as a matter of public policy.

Democrats argued during the recession that an FTT should be levied on Wall Street as a penalty for their behavior that Democrats believe led to the recession and to help pay for the recovery.  By the same logic, a tax on hawala would help pay for the security costs necessitated by Islamism.  Democrats will argue against a hawala tax on “racial” grounds, but they will not be able to oppose the economics of FTTs since they’ve wanted it since the days of John Maynard Keynes.

A hawala tax would be a new and innovative concept, but it is a logical extension of similar proposals made in the context of remittances from the U.S. to Mexico by illegal immigrants.  For example, writer Brenda Walker once proposed a 10 to 15 percent tax on outbound remittances.  Walker argued that the tax revenues could be channeled to U.S. hospitals to help recover the costs of health care for immigrant patients.

State experience

A hawala tax would be politically easier to enact at the state level than the federal level.  Although no state has adopted such a tax yet, states are experienced with a wide variety of taxes that work a similar way.

New York imposes a stamp tax on certain Wall Street financial transactions.  But the most relevant state tax law comes from Oklahoma.  Due to concerns about remittances by illegal immigrants, Oklahoma charges a $5 tax fee on overseas wire transfers of less than $500, and a 1 percent tax on remittances greater than $500.  In less than its first year of being enacted, Oklahoma received $4 million in tax revenues which were allocated to Oklahoma’s Drug Money Laundering and Wire Transmitter Revolving Fund.

North Carolina considered a 5 percent remittance tax and Arizona considered an 8 percent tax, but those measures did not pass.  The Georgia legislature considered a 5 percent illegal immigrant fee in 2006 that failed, and then tried again in 2010 with a 2 percent remittance fee that didn’t not make it out of committee.  However, the Georgia bill was co-sponsored by the Georgia House of Representatives majority leader, the majority whip, and the chairman of the banking committee, suggesting that there is enough powerful backing for a successful attempt in future legislative sessions.

The failed remittance tax legislative initiatives may suggest that a smaller tax along the lines of Oklahoma’s 1 percent tax would be easier to pass into law.

Outside the U.S., it’s worth noting that the Philippines taxes inbound remittances.  U.S. states could consider a similar levy on inbound hawala.

Enforcement

On the downside, hawaladars would self-report their taxes.  If only 17 percent of hawaladars register as MSBs, what chance do hawaladars have of paying their taxes?  Due to that potential compliance problem, any hawala tax legislation must include a rigorous tax whistleblower provision.  Persons with knowledge of a hawaladar failing to charge and pay hawala taxes could be entitled to a 30 percent award of any taxes due by the hawaladar.  Many hawala customers will keep their mouths shut, but there is no honor among thieves.  The 30 percent lure would help improve hawala tax compliance.

Also, if the hawaladar does not comply, the tax authorities would be all over them.  Tax offices throughout history have been far more aggressive than modern financial regulatory commissions that often fall captive to the industries they’re supposed to regulate.

Charging a tax also puts the burden on the hawaladars rather than putting a burden on local law enforcement or on bloated intelligence agencies to track and prohibit hawala behavior.

Legislation

Legislators would have to define the terms used in their legislation very carefully to withstand legal challenge and to ensure that the tax does not adversely affect legitimate commercial activity.

Distinctions should be made between an ordinary domestic wire transfer, an overseas wire transfer, and domestic and overseas hawala transfers, and transfers of any kind to countries at high risk for terrorist financing and money laundering.

A wire transfer is an electronic method of moving money from one person or institution to another.  A hawala transfer is a money transfer without money movement.

The language of the legislation would have to be crafted carefully to tax the intended transaction and nothing else.  Lawmakers could decide to tax all overseas remittances, but language that open-ended could hit all banks, wire companies, and money service businesses—even the ones already doing their due diligence.  The preferred objective would be to hone in on international hawala transactions, since those present the greatest risk to U.S. security.  Or the surcharge could be imposed on all remittances to countries listed as high-risk, for example, by the U.S. Treasury Department.

According to one hawala flow estimate of private remittances from 1981 to 2000, 73 percent of Algeria’s hawala transactions were “unrecorded,” 59 percent for Bangladesh, 16 percent for India, 23 percent for Indonesia, 68 percent for Iran, 55 percent for Pakistan, 55 percent for Sudan, and 17 percent for Turkey.  That makes for an average of approximately 45 percent of remittances being unrecorded to countries with large Muslim populations.

ACORN International has estimated that 20 to 40 percent of remittances worldwide come through hawala, but speculated that the true figure could be as high as 75 percent.

The World Bank estimated that remittances from the U.S. to the Middle East totaled $3.8 billion in 2010.  World Bank data does not include informal remittances (ie, hawala) in their estimates.

If $3.8 billion represents only formal transfers, and hawala represents 40 percent of remittances to the Middle East, that means $5.7 billion is transferred from the U.S. to the Middle East in undocumented hawala transactions.  A 1 percent hawala tax could therefore yield approximately $50 million in annual tax revenues.

However, due to variations in collection rates, mixed compliance, administrative costs of implementation, an eventual decline in the number of hawala operators, and the difficulty in estimating the real volume of hawala transactions, actual collections would probably be much lower.

Do nothing

Another approach would be to keep the status quo.  Let Faisal Shahzad II get thousands of dollars by hawala brokers to fund the next attack against New York.  Let the Ft. Hood shooter, Pakistani immigrants, or Somali immigrants send money out of the U.S. economy and into the operating accounts of Lashkar-e-Taiba and al-Shabaab.  This approach has the advantage of creating no new direct costs and requires no changes in behavior.

In conclusion

America may not be ready for an outright hawala ban.  But something more is needed than another layer of regulatory oversight.  A federal or state-by-state hawala tax would force hawaladars to open up their books, file tax returns, and serve as an acknowledgment that the risks created by their business present genuine costs that must be recouped by the United States.  A whistleblower reward program could help improve compliance and force hawaladars out from underground.

For those that remain underground, U.S. attorneys will have the tax laws on their side as an additional weapon to use in the prosecution of terrorist financiers.  As an added bonus, the tax could net the U.S. as much as $50 million a year in tax revenues to help defray the enormous security costs to protect American from terrorism that was funded partly by hawala in the first place.

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6 comments

  1. “A federal or state-by-state hawala tax would force hawaladars to open up their books…” really? Good luck with that….

    Most don’t keep “books”. I agree with you that this is one of many possible helpful steps, I just think that anyone believing this would work is naive.

    It’s an excellent article but I believe this problem requires a host of solutions and some serious action. A hopeful “tax” and a promised visit from the IRS won’t fix it, not by a long shot.


    • Fair enough, Goldy. That’s why I’d only argue for such a tax if it included a solid whistleblower reward system to help “encourage” compliance.


  2. [...] Bank data includes only formal transfers, but it is likely that another $6 billion in transferred to the Middle East through the informal and undocumented hawala mo….  Imposing a simple 1 percent tax on such overseas remittances would be a mild, positive step in [...]


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