Smith and Ricardo: Classical Economists and the Origins of TBML

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Economics has been labeled a “dismal” science for a variety of reasons, so it should not be surprising that an economist would take advantage of the current pandemic stay-at-home orders to read what some would consider dreary works: Adam Smith’s The Wealth of Nations (1776) and David Ricardo’s On the Principles of Political Economy and Taxation (1817). What was surprising was discovering the first mentions of the structure and reasoning behind trade-based money laundering (TBML), known as “carousel fraud” or “missing trader fraud” in such dismal books.

In Smith’s chapter on drawbacks (excise or import duty remitted on imported goods that the importer re-exports rather than selling domestically), he mentions that this remittance is useful “only in those cases in which the goods for the exportation of which they are given, are really exported to some foreign country; and not clandestinely re-imported into our own” and “have frequently been abused in this manner, and have given occasion to many frauds equally harmful both to the revenue and to the fair trader.”1 The common definition of carousel fraud is that imported goods are sold from one trader to another before being exported. When the goods are exported, the exporter can claim any taxes involved (drawbacks) paid on the goods (as exports are zero-rated) from the government. This process can be repeated several times with the goods going around as if on a carousel.

Furthermore, Ricardo appears to touch on the reasoning for conducting carousel fraud when he mentions what is known today as the value-added tax (VAT). Toward the end of his book, he reiterates a statement from Jean-Baptiste Say in 1803 on “inconveniences,” when a “tax on a manufactured commodity is levied at an early, rather than at a late, period of its manufacture…through whose hands [manufacturers] the commodity may successively pass, must employ greater funds in consequence of having to advance the tax.”2

In her article for the Organized Crime and Corruption Reporting Project,3 Annie Todd reported how cross-country VAT avoidance schemes cost the European Union (EU) about 50 billion euros per year. She also describes how they occur: Fraudsters import goods VAT-free from other EU countries and then sell them to domestic buyers while charging them taxes. Afterward, the fraudsters disappear, leaving the government unable to collect the VAT.4

Natalia Stankiewicz, an ACAMS member and former manager of Deloitte Advisory’s Financial Crime and Forensic Practice, remarked that since the EU guarantees the free movement of goods (e.g., capital, services and people), it becomes challenging to control and monitor intracommunity trade. Stankiewicz explains the VAT carousel fraud, also known as “missing trader intra-community VAT fraud,” where perpetrators engage in the importation of goods and do not merely underreport the value of the imports; the importer also disappears without remitting any VAT to the national tax administration once the transactions conclude. The most common goods involved in this scheme are cell phones, microprocessors and chips, natural gas and electric power certificates (guarantees of origin), telecommunications services, raw metals or semi-processed elements, video game controls, laptops, tablets, cereals and industrial crops.5

It is interesting to observe that not all TBML methodologies, such as the Black Market Peso Exchange,6 have evolved in the past decade or two but were occurring more than two centuries ago. Although Ricardo does not mention any remedies to counter VAT carousel fraud, other than implying to tax the final product when it is purchased, Smith espouses, “[t]he high duties [tariff] which have been imposed upon the importation of many different sorts of foreign goods…served only to encourage smuggling, and in all cases have reduced the revenue of customs below what more moderate duties would have afforded”7 and more than likely “the hope of evading such taxes by smuggling gives frequent occasion to forfeitures and other penalties, which entirely ruin the smuggler”8 that TBML methods are intended to conceal. So, while some would maintain that lowering tariffs would decrease the “temptation” for smuggling,9 there is the disincentive to engage in TBML via increased “forfeitures and other penalties” called for by Smith, which requires greater national and international cooperation and coordination among present-day anti-money laundering agencies and organizations.

Dr. Robert Gay, CAMS, associate professor, National Intelligence University (X-Corp Solutions), Bethesda, MD, USA, rdgayjr@hotmail.com; U.S. Capital Chapter member

Disclaimer: The views expressed are solely those of the author and are not meant to represent the opinion of any employer.

  1. Adam Smith, Wealth of Nations (1776; reproduced by Amherst, NY: Prometheus Books, 1991), 391.
  2. David Ricardo, The Principles of Political Economy and Taxation (1817, reproduced by Mansfield Centre, CT: Martino Publishing, 2016), 258.
  3. “About Us,” Organized Crime and Corruption Reporting Project , August 24, 2007, https://www.occrp.org/en/about-us . The Organized Crime and Corruption Reporting Project is an investigative platform for a global network of independent media centers and investigative journalists to publish their stories exposing crime and corruption.
  4. Annie Todd, “Cross-Country Carousel Fraud Stopped,” Organized Crime and Corruption Reporting Project, July 4, 2019, https://www.occrp.org/en/daily/10122-cross-country-carousel-fraud-stopped#:~:text=Carousel%20fraud%20is%20the%20most,to%20collect%20the%20tax%20money
  5. Natalia Stankiewicz, “White-Collar Crime: The Carousel of VAT Abuse,” ACAMS Today, June 9, 2017, https://www.acamstoday.org/white-collar-crime-carousel-of-vat-abuse/
  6. “Colombian Black Market Peso Exchange,” Financial Crimes Enforcement Network, November 1997, https://www.fincen.gov/sites/default/files/advisory/advisu9.pdf
  7. Smith, 551.
  8. Smith, 563.
  9. David Bier, “Adam Smith’s Recommendation to End Illegal Immigration,” Competitive Enterprise Institute , January 24, 2013, https://cei.org/blog/adam-smiths-recommendation-end-illegal-immigration

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