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Phony import export { November 1 2002 }

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Phony Prices May Hide Import-Export Profits From IRS

By Jonathan Weisman
Washington Post Staff Writer
Friday, November 1, 2002; Page E01

Razor blades imported from Britain for $113 apiece. Tweezers from Japan for $4,896 each. Cut rubies from Burma for $38,192 per carat. And for U.S. trading partners, the deals of the century: car seats exported to Belgium for $1.66 each, missile launchers to Israel for $52 a shot, wristwatches encased in precious metals to Colombia for $8.68 a pop.

Lurking in reams of 2001 government trade data are thousands of such wildly mispriced transactions, and those trades may hint at corporate tax evasion and criminal money laundering on a grand scale, according to two academic researchers who have been mining the data for more than a decade.

Simon J. Pak, a finance professor at Pennsylvania State University Great Valley, and John S. Zdanowicz, the director of the Center for Banking and Financial Institutions at Florida International University, plan today to release their latest analysis of overpriced U.S. imports and underpriced exports, estimating that corporations manipulated international trades last year to shave $53.1 billion from their tax bills.

That is a 19 percent increase from the tax cheating that Pak and Zdanowicz believe they uncovered in 2000, and an 89 percent increase from 1993.

For a decade, government officials and fellow academics have questioned such eye-popping numbers. One senior Treasury analyst bluntly dismissed the tax-avoidance totals as "much too large." Some of those outlandish prices were surely simple typographical or categorizing errors on customs forms, the Treasury official and other tax and trade experts say.

The U.S. Customs Service is the only government agency that has been seriously studying the pricing schemes to prosecute money laundering and tax evasion. Customs uses its own research along with expert testimony from Pak and Zdanowicz.

But even skeptics are beginning to concede that although their numbers may be inflated, Pak and Zdanowicz are on to something: Overpricing imports or underpricing exports is a relatively easy way to shift large amounts of taxable income out of the United States, or ill-gotten gains into the country.

After the Sept. 11, 2001, attacks, the techniques have been recognized as a potential mechanism to finance terrorism.

"We do not cast wary glances at their stuff," Customs Service spokesman Dean Boyd said of the analysis. "It's very serious, because you can do this with any commodity."

The Customs Service recently shifted millions of dollars into its own effort, the Numerically Integrated Profiling System, to expand its focus on terrorism financing. The General Accounting Office, which in 1995 drafted a generally disparaging report that attributed wild price fluctuations to recording errors, is examining the issue again, this time analyzing the mispricing of commodities as a means to mask money laundering and terrorism financing.

The Treasury Department and the IRS, though still skeptical, are taking a second look at Pak and Zdanowicz's computer program and the validity of their findings, in part because Sen. Byron L. Dorgan (D-N.D) secured a $2 million grant for the researchers to force the government to take their work seriously. Pak and Zdanowicz do not have access to the names of the companies that do the trading, but, Dorgan noted, the IRS does.

"The IRS and the Treasury have been in a deep sleep on this subject," Dorgan said. "I want Treasury and the IRS to look at this, to say this is a big, serious problem."

Other academics are expressing more interest. Deborah L. Swenson, an economist at the University of California at Davis, combed through export data for a paper published last year and she, too, found that trade prices seemed to fluctuate not according to the world market but according to tax-rate changes. In other words, U.S. companies appeared to be manipulating the prices of imports from their foreign subsidiaries to maximize tax advantages.

"The interest is definitely growing," said Mihir A. Desai, an economist at Harvard Business School who is studying how corporations shift income to avoid taxation.

It is relatively simple. For example: A Japanese automaker manufactures a car radio for $100, but its U.S. subsidiary buys it for $199, then sells it for $200. The company's bottom line hasn't changed, but the taxable profit in the United States is now just $1 instead of $100. A tax bill that would have been $34 is reduced to 34 cents.

Conversely, if a U.S. manufacturer exports a bulldozer to its Colombian subsidiary for $1,742; the Colombian company sells it to a buyer for $28,000. The U.S. company's cost of producing the bulldozer can be written off its income taxes , but the profit from the sale would reside in Colombia. That profit would be subject to U.S. taxes only after it is "repatriated" across the border, presumably in a bad economic year when the company's taxable U.S. income is low or nonexistent.

The same kinds of schemes can move vast amounts of money around the globe virtually undetected.

After the Treasury Department linked three Yemeni honey companies to Osama bin Laden's terrorism-financing operation, Pak and Zdanowicz examined the U.S.-Middle East honey trade. They found that in 2000, someone shipped 182,509 kilograms of honey to Yemen for $2.63 per kilogram, a price 38 percent higher than the average honey price of $1.91 a kilogram.

At that rate, the honey exporter would have received $131,406 in excess proceeds just as the Sept. 11 hijackers took up residence in the United States. Where that money went is unknown.

Other cases are not so shrouded in mystery. In 1999, the owners of an Argentine export company pleaded guilty to U.S. charges connected to a $130 million money-laundering scheme involving wildly inflated gold shipments to the United States. In 1997, a Los Angeles herbal-product importer in Los Angeles pleaded guilty to evading $39 million in taxes. Sunrider Corp. shipped profits to Hong Kong by inflating the cost of imports by as much as 900 percent.

Those cases aside, Zdanowicz said the government "is shutting down the front door on the illegal movement of money, focusing on banks, insurance companies and other financial institutions. But the back door is wide open, international trade."

In 1998, after Switzerland adopted one of the most stringent anti-money-laundering laws in the world for its banks, Zdanowicz and Pak examined the amount of money moving from Switzerland to the United States through trade before and after the law was enactment. The numbers had doubled.

Such cases have not overcome all the skepticism. One Treasury official said dramatic examples of out-of-whack import or export prices may look interesting, but they are the ones most likely to be simple errors. In 1995, the GAO made the same point. GAO auditors found that an $8,736 shipment of gold seemingly valued at more than 379 times its market price was less than sinister. Two kilograms of gold had been recorded as 2 grams.

The researchers' methods are unorthodox. In 2001, the Treasury Department maintained 16,390 import categories and 8,568 export categories, and for each category Pak and Zdanowicz determined a median price for all U.S. transactions. They then ran 54.9 million transactions through their computer program to find prices more than 25 percent higher or lower than the median.

Economists usually write programs to throw out such outliers on the assumption they are mistakes. Swenson did that, but even when she focused on prices closer to the average, she found manipulation.

Pak readily conceded that he and Zdanowicz pick up some recording errors.

But, he said, that cannot explain the number of mispriced transactions they found. In 1998, he noted, the United States imported nearly 602,000 single-lens-reflex cameras from Japan for an average price of $239. That same year, the United States exported to Japan 240,000 single-lens-reflex cameras, more than one-third of which were priced at an average of $11.39, he said. Those cut-rate prices surfaced in multiple export entries, in multiple months from multiple ports.

"It's difficult to ascribe that to a recording error," he said.

2002 The Washington Post Company

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