draining development.pdf - Khazar University

252 Draining Development?As recently reviewed by Fuest and Riedel (2009), the existing studies arepurely descriptive, employ the marginal tax rate to calculate the tax gap,and do not account for the reverse effects of profits shifted into developingcountries, some of which do have significantly lower corporate tax rates. 20In addition, recent work on the demand for tax haven operations suggeststhat tax havens may not have purely negative consequences (Desai, Foley,and Hines 2006). This work indicates the following:• Multinational parent companies in industries that typically face lowforeign tax rates, those that are technology intensive, and those inindustries characterized by extensive intrafirm trade are more likelythan others to operate in tax havens.• Firms with growing activity in high-tax countries are most likely toinitiate tax haven operations, and the reduced costs of using tax havensare likely to stimulate investment in nearby high-tax countries.The same studies that provide estimates of large tax gaps created indeveloping countries by illicit flows from tax-induced manipulationsalso need to provide answers to puzzles related to (1) the sensitivity ofFDI to tax rates, (2) the broadly similar levels of tax rates across countries,and (3) the buoyancy of tax collections in the 1990s.Consistent with economic theory, we have good empirical evidencethat FDI responds to statutory tax rates and other features of the tax system.21 Meanwhile, it is popularly thought that MNEs are finding moreand more ways to shift income (including by optimizing financing structures,choosing advantageous accounting treatments, and using offshorefinancial centers and tax havens). 22 Taken together, these facts suggest thatthe sensitivity of FDI to tax factors should be decreasing over time giventhat the increasing availability of income shifting practices suggests thatthe burdens of high host country rates can be more easily avoided (withoutthe need for costly reallocations of real investment). However, thesensitivity of FDI to tax factors appears, if anything, to be increasing overtime. 23 This is consistent with tax avoidance rather than tax evasion.Stöwhase (2006) finds that, in addition, the elasticity of FDI to taxincentives in the European Union differs strongly according to economicsector. While taxes are insignificant as a determinant of FDI in the primarysector, tax elasticity is substantial in manufacturing, and it is evengreater in service industries. 24 The increasing differentiation of products