Are Tax Havens Good Neighbors? An LDC Perspective

Abstract:     
Tax competition and spillover models offer ambiguous predictions of tax haven impacts on non-tax havens. The implications of tax havens for less developed countries (LDCs), in particular, are not well understood and are little studied. This paper investigates the impact of tax havens on foreign direct investment (FDI) in non-tax haven LDCs. We investigate spillover and agglomeration factors by including measures of proximity to the nearest tax haven and the level of FDI inflows in the nearest tax haven. Employing cross sectional data of 115 LDCs from 1990 to 2006, we find evidence of spillovers from tax havens to nearby LDCs. FDI inflows in LDCs are positively and significantly related to FDI inflows in the nearest tax haven. Geographic diffusion has nuanced effects. LDCs at a medium distance to the nearest tax haven have higher levels of FDI than LDCs that are close to a tax haven. On the other hand, LDCs at a medium distance to a tax haven are less influenced by FDI spillovers compared with LDCs at closer proximity. Taken together, our results suggest that tax havens make good regional neighbors, but not good immediate neighbors for LDCs. These findings are robust to several model specifications, including one with spatially correlated error terms..

Number of Pages in PDF File: 26

Keywords: Tax havens, Foreign Direct Investment, Less Developed Countries, Spatial Econometrics

JEL Classification: H87, F21

working papers series