Why is money laundering necessary?
In: Economics
If I’m making minimum wage on my tax returns yet I’m also spending ridiculous sums of money on things I could never afford on that pay it starts to look pretty suspicious. Money laundering is the process of making illegitimate income look legitimate so no one questions how you got it.
Because if you tell the government that you make $50k a year but you are spending upwards of $200k a year, the government is going to want to know where that extra $150k came from and why you aren’t paying taxes on it.
That is how they took down Al Capone – they couldn’t get him for organized crime, but they _could_ get him on tax evasion because his spending was _way_ beyond his reported income.
You could, of course, tell the IRS about your income from illegal sources (there is a form for this and you are legally required to do it) but – as you can imagine – criminals aren’t too keen on admitting they are criminals on government forms.
The purpose of money laundering is to take the illegal money you earn and run it through a legitimate business so it now looks like legitimately earned money. You pay your taxes and can now spend the money without the government asking questions you can’t answer.
You steal some money from your friends, and as a five year old, your parents are going to know something is up if you go and buy that Lego set for 100 bucks, because they know your allowance doesn’t give you anywhere near that much money. So maybe you set up a lemonade stand. The stand only makes 20 bucks today, but you stuff some of your stolen money in the jar, and tell your parents you had a great day, and sold 50 bucks worth of lemonade. Do that a few times, and now the money is “clean”, and your parents dont think you did something bad to get it.
Suppose you’re a drug dealer and you earn a lot of money that you can’t admit to having. Usually, one presumes, this money is in cash. So, practically speaking, what can you do with this cash? There are several problems you have to deal with:
– Security: having tens or hundreds of thousands of dollars in cash makes you vulnerable to theft. Where do you physically put this cash so it’s safe from loss or fire, etc?
– Loss of value: inflation increases over time. $10 in 1980 is worth $2.75 or so in 2024. If you keep your money in cash, you’re losing some of its value every day.
Most people address this problem by putting their money in a bank (solves security problem) and subsequently investing it in some way (solves loss of value problem).
The issue is that you cannot do that because both things are reported to the IRS and you’re going to have to come up with a reason why you have all that money and why it’s in cash.
Enter money laundering. There are lots of ways to do this, but here’s an easy one: suppose you have a store with walk-up sales like a bakery. You sell cookies. On a given day, you sell 10 cookies for $2 each, a total gross sales of $20. You can enter in your cookie books that you sold 100 cookies for $2 each, a total gross sales of $200, which allows you to add $180 of your drug money to the till and legally deposit it in the bank. This money can be declared and taxed legally and you are free to spend it. It’s unlikely that the IRS is going to be counting the number of people that walk in the door to buy cookies and, generally speaking, local law enforcement won’t care about it at all.
There are issues with this approach, of course. You would still have to have enough flour and eggs to make 100 cookies in case the IRS came poking around. It’s just an easy model to understand. A better one would be a service-based establishment that didn’t rely so much on raw materials, but, that’s the basic model.
Clean money is money you can account for by legal activity. I work on my buddy’s car, he pays me, I pay tax on that (yup, you are supposed to), that money is clean.
Even money that might seem dirty might be clean, I go to the casino, toss everything on black, make a killing. Again, I can account for the legal activity that is associated with that money.
I sell a kilo of cocaine, after paying the supplier, I can’t account for the profits. At a small scale this won’t get noticed, but what about when I have suitcases of money? I need a method, usually a cash business like a laundromat (hence the term laundering) where I can disperse my ill gotten gains into legal gains.
Concrete contracts, art, auto shops, etc; all popular fronts for laundering money because it can be very challenging to verify that the work wasn’t done. For example, I can’t really tell that that laundromat *didn’t* do XXX in business, particularly if it is a legit laundromat and people are going in and out of there. You might have to look at the receipts for dry cleaning, then go find the customer and ask whether they truly had dry cleaning done. Otherwise, the record is what it is. Incidentally, falsifying business records is a serious crime for this reason, among others.
To start with money laundering is illegal so it is NOT necessary.
People gain money by doing illegal things like selling illicit drugs, human trafficking etc…
They want to make it look like they made/acquired the money legally.
It isn’t necessary. It’s illegal.
If you are asking why people do it anyways, it’s because they have acquired money through some sort of improper means. They can also do this to avoid paying taxes, although that is called “tax evasion.”
Essentially, the goal of money laundering is to start with a pile of money that you don’t want to admit where it came from, and go through some kind of illicit process to end up with a “fresh” pile of money that seems to have come from somewhere legitimate. For instance, maybe you’re part of a gang and you’ve made some money selling drugs, or running an illegal casino, or something, but you don’t want to have to admit that if the IRS or the police ever ask how you got the money in your bank account. Usually this would involve moving the money through a company with a lot of cash transactions and poor records, or by shuffling it through a foreign offshore corporation, or that sort of thing.
Again, however, this isn’t “necessary.” It’s a crime. The people who do it are criminals who want to avoid leaving evidence of their crimes, or to cheat on their taxes.
Already great answers on here so I’ll just add with a visual example: Breaking Bad. (Some spoilers for those who haven’t seen the show yet!)
Walt makes a ton of money selling meth. The money is dirty, and they don’t make much money legally. What do they do to “clean” it? They buy a car wash.
Skylar works the register. Occasionally you’ll see her perform an “imaginary” sale with no one there. Write in your ledger that someone paid for the premium car wash, put your dirty money in as profits, when in reality the washing of the car never happened.
“This little pink thing is you — get it? Pink? Pinkman? You’re partying hardy, knocking boots with the chicky-babes, when this guy comes along. This is the tax man, and he’s looking at you. He sees a young guy, in a big, fancy house, unlimited pocket money, and no job. Now, what’s the conclusion the tax man makes?”
“I’m a drug dealer.”
“EH! Wrong! Million times worse! You’re a tax cheat. So what does the tax man do? He takes every penny and you go in the can for felony tax evasion. (Saul throws the little pink thing in a garbage can.) Ouch! What was your mistake? You didn’t launder your money!”
-Saul Goodman and Jesse Pinkman, Breaking Bad.
It’s only necessary if you want to spend it on things that don’t take cash. For example real estate, new cars, airplane tickets, and other big ticket items.
Transforming cash into electronic money means entering into the legitimate “above board” system where things can be tracked.
If you walk into a bank and deposit $100k in cash, you can make up a story without proof the first time and no one is going to care. But if you do that every week, the feds are going to get supicious without some sort of paper trail.
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