The effect of tax harmonization in the Southern African development community on foreign direct investment

This paper investigates the effect of tax harmonization on foreign direct investment (FDI) in the Southern African Development Community (SADC). Previous attempts aimed at addressing relatively unsatisfactory FDI flows into the region have been largely unsuccessful, compounded by the existence of varied tax rates, laws and tax policies amongst SADC countries. The study employs dynamic panel estimation techniques to test the underlying economic specifications. Specifically, the feasible generalized least squares and the difference GMM approaches are used to test the causal link between FDI and taxation. These approaches are complemented by the Extreme-Bound Analysis (EBA) approach to perform a robustness test and sensitivity analysis over the period 1990-2010. The EBA technique helps to identify robust measures of economic policy changes from the taxation and FDI model. The paper modifies relevant data, per Sudsawasd and Mongsawad (2011), for SADC countries, expanding the number of years from 1995-2006 to 1990-2010, with more relevant and available data. Findings of a first attempt to investigate the linkage between taxation (tax rates and policy) and FDI, using an eclectic panel data modeling approach are presented. A new value added tax harmonization variable is introduced (in addition to a corporate income tax harmonization variable) via a tax policy harmonization measure in the panel empirical investigation, complemented by a sensitivity analysis (using the EBA analysis technique) on the causal relationship between taxation and FDI inflows. The main finding from the study indicates a positive and significant relationship between tax harmonization and FDI. The causal relationship is more robust when errors in the regressors (for instance contemporaneous correlation, heteroskedasticity, cross-sectional dependence, country-specific challenges, endogeneity) are controlled for. From a policy perspective, the paper provides empirical evidence to support the argument for the effective use of taxation towards stimulating regional FDI inflows. Policy considerations towards improved tax harmonization emanating from the paper include the need for individual SADC governments to promote national tax policies aimed at supporting regional tax harmonization objectives towards enhanced FDI, through strengthening existing tax agreements and treaties (such as the SADC 2002 Memorandum of Understanding on Taxation and the 2006 SADC Finance and Investment Protocol).