There is uncertainty about the relationship between aid and taxation revenue. The question of whether aid undermines tax effort and revenue has been rigorously researched but with conflicting conclusions. The paucity of data is a key constraint and there is debate on the methodology of the studies with researchers failing to replicate findings. An influential econometric analysis found a negative association between aid grants and tax revenues, though the authors note that this relationship has become weaker over time and can be moderated by policymakers focusing on strengthening tax collection (Benedek et al., 2011). Two further econometric studies using a revised methodology and dataset fail to find a consistent significant relationship between aid and tax revenue (Clist, 2014; Morrisey et al., 2014). The authors of one of these studies conclude that there are high levels of heterogeneity amongst countries and types of aid which would prevent a robust relationship at an aggregate level (Morrisey et al., 2014).
Key reading
Morrisey, O., Prichard, W., & Torrance, S. (2014). Aid and Taxation: Exploring the Relationship Using New Data. Brighton, UK: Institute of Development Studies.
This econometric analysis paper uses the new ICTD dataset, which the authors argue is notably more accurate than earlier datasets. It finds that there is no consistent, significant relationship between aid and tax performance. In general they find a positive, though not significant, relationship between net aid and government revenue. In sub-Saharan African countries they find a significant relationship between tax revenue and aid when given as loans.
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Prichard, W., Cobham, A., & Goodall, A. (2014). The ICTD Government Revenue Dataset (ICTD Working Paper 19). Brighton, UK: Institute of Development Studies.
This paper presents a new government revenue dataset which the authors argue is more complete and consistent than previous efforts. Econometric analysis using this data finds that tax collection in developing countries has improved markedly and consistently across income groups and regions. Progress has been most rapid among low-income countries, most notably in Africa. Non-resource tax collection has increased but still remains at a low level and is not sufficient to produce all of the necessary revenue. The data suggest that for developing countries, non-resource tax collection was more resilient than other revenue streams to the 2008 financial crisis. The authors speculate that this may reflect less integration of low-income economies into the global economy.
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Benedek, D., Crivelli, E., & Gupta, S. (2012). Foreign Aid and Revenue: Still a Crowding Out Effect? (Working Paper 12/186). Washington, D.C.: IMF.
This econometric analysis finds that a negative relationship between ODA grants and tax revenue. These results are reasonably robust across income levels and different geographical regions, and appear to be stronger in low-income countries. However, the impact of ODA grants on tax revenues appears to be weakening over time when compared with earlier studies. The authors argue that policymakers can manage the negative impact of grants by giving adequate attention to strengthening domestic capacity for revenue mobilisation.
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- Mascagni, G., Moore, M., & McCluskey, R. (2014). Tax revenue mobilisation in developing countries: Issues and challenges. Luxembourg: European Union. See document online
- Clist, P. (2014). Foreign aid and domestic taxation: Multiple sources, one conclusion (ICTD Working paper 20). Brighton: Institute of Development Studies. See document online
- Von Haldenwang, C., Morrisey, O., Ivanyna, M., Bordon, I. & Von Schiller, A. (2013). Study on the vulnerability and resilience factors of tax revenues in developing countries. See document online