A paired catchment methodology was used with more than 3 years of data to test whether forests increase base flow in the dry season, despite reduced annual runoff caused by evapotranspiration (the “sponge-effect hypothesis”), and whether forests reduce maximum runoff rates and totals during storms. The three study catchments were: a 142.3 ha old secondary forest, a 175.6 ha mosaic of mixed age forest, pasture, and subsistence agriculture, and a 35.9 ha actively grazed pasture subcatchment of the mosaic catchment. The two larger catchments are adjacent, with similar morphology, soils, underlying geology, and rainfall. Annual water balances, peak runoff rates, runoff efficiencies, and dry season recessions show significant differences. Dry season runoff from the forested catchment receded more slowly than from the mosaic and pasture catchments. The runoff rate from the forest catchment was 1–50% greater than that from the similarly sized mosaic catchment at the end of the dry season. This observation supports the sponge-effect hypothesis. The pasture and mosaic catchment median runoff efficiencies were 2.7 and 1.8 times that of the forest catchment, respectively, and increased with total storm rainfall. Peak runoff rates from the pasture and mosaic catchments were 1.7 and 1.4 times those of the forest catchment, respectively. The forest catchment produced 35% less total runoff and smaller peak runoff rates during the flood of record in the Panama Canal Watershed. Flood peak reduction and increased streamflows through dry periods are important benefits relevant to watershed management, payment for ecosystem services, water-quality management, reservoir sedimentation, and fresh water security in the Panama Canal watershed and similar tropical landscapes.