DP8570 | Tax havens or safe havens

Publication Date

01/09/2011

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Abstract

Our aim is to explain how a small country can be viable as an international banking center (IBC). We build a model in which mobile investors choose between two banking centers located respectively in a small country and in a large country. These countries compete in two instruments, taxation and institutional infrastructure. It follows that an IBC can be a tax haven, a safe haven, or both. A small country that hosts an IBC is a safe haven when it is able to provide a high level of institutional infrastructure, whereas it chooses to be a tax haven when it cannot be competitive in institutional infrastructure. Even in this last case, an IBC need not be as bad as claimed in the general press because its presence fosters institutional competition across countries, which is ultimately beneficial to all investors.