Tax Havens and FDI Spillovers: Implications for LDCs

Tax competition and spillover models offer ambiguous predictions concerning the economic impact of tax havens 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 non-tax haven countries in terms of foreign direct investment (FDI). We investigate the importance of agglomeration effects by accounting for the level of FDI inflows as well as the role of geography by measuring proximity to the nearest tax haven. Our analysis yields several interesting findings. First, using panel data for 142 countries, we find evidence of positive spillovers from tax havens to nearby LDCs, but not to nearby developed countries. Second, restricting our panel to LDCs, we find the positive effect of tax haven FDI on LDCs to be robust. Third, we find that geographic distance matters for financial flows: LDCs which are the closest to a nearby tax haven benefit the most in terms of FDI inflows. This result is robust to including a lag of the dependent variable and accounting for spatial interdependence of FDI. We conclude that tax haven activity has beneficial implications for FDI inflows of nearby LDCs