Working Paper: NBER ID: w12802
Authors: Dhammika Dharmapala; James R. Hines Jr.
Abstract: This paper analyzes the factors influencing whether countries become tax havens. Roughly 15 percent of countries are tax havens; as has been widely observed, these countries tend to be small and affluent. This paper documents another robust empirical regularity: better-governed countries are much more likely than others to become tax havens. Using a variety of empirical approaches, and controlling for other relevant factors, governance quality has a statistically significant and quantitatively large impact on the probability of being a tax haven. For a typical country with a population under one million, the likelihood of a becoming a tax haven rises from 24 percent to 63 percent as governance quality improves from the level of Brazil to that of Portugal. The effect of governance on tax haven status persists when the origin of a country's legal system is used as an instrument for its quality of its governance. Low tax rates offer much more powerful inducements to foreign investment in well-governed countries than elsewhere, which may explain why poorly governed countries do not generally attempt to become tax havens -- and suggests that the range of sensible tax policy options is constrained by the quality of governance.
Keywords: Tax Havens; Governance Quality; Foreign Investment
JEL Codes: H25; H87; K10
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| low tax rates (H29) | foreign investment in well-governed countries (F21) |
| governance quality (H11) | elasticity of foreign investment with respect to tax rates (F21) |
| governance quality (H11) | tax haven status (H26) |
| better governance (H11) | higher likelihood of becoming a tax haven (H26) |