Edited by B. Mak Arvin and Byron Lew
The principal aim of this chapter is to demonstrate that there is no robust or consistent relationship between aid, in total or whether disaggregated into grants and loans, and tax revenue. We demonstrate that although we can replicate the negative coefficient on aid variables in a tax revenue regression that is often claimed to show that aid reduces tax effort (Gupta et al., 2004; Benedek et al., 2012) this is not a robust finding. Specifically, we show that significance of coefficients on the aid variables can be eliminated by altering the specification or estimator or by introducing lags to aid or by altering the sample. Furthermore, changing the analysis from using annual observations to using sub-period averaged data one can obtain results that suggest a positive effect of aid on tax revenue (Clist and Morrissey, 2011; Morrissey et al., 2014) but these results also are not very robust. We conclude that no general claims that aid reduces (or increases) tax effort are credible; although it is easy to find associations between aid and tax in the data, these are inherently fragile and can often be explained by structural characteristics of the countries (factors associated with low tax are also associated with high aid). There is no reason to assert that aid has any consistent effect on tax effort.
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