Does foreign aid reduce tax revenue? Further evidenceApplied Economics, 2014, vol. 46, issue 4, 359-373 Abstract: A common criticism of foreign aid is that it reduces domestic tax effort. Empirical research on the issue has been hampered by the failure to tackle endogeneity issues effectively. We use measures of geographical and cultural distance to donor countries as instrumental variables to uncover the causal effect of aid on tax revenue in a panel of 93 countries. The tax to GDP ratio is found to decrease following aid inflows. This reduction in tax effort is statistically and economically significant; a one SD increase in aid causes a 0.52 percentage point drop in the tax-to-GDP ratio. The results indicate that the effect is driven by unconditional grants, whereas aid given as loans induces recipient governments to improve their tax effort. Our results are robust to changes in the sample and the use of a nearest neighbour matching technique to account for nonrandom assignment of aid. Our identification strategy is sharpened by the use of a difference-in-difference estimation strategy that leverages a natural experiment in which aid flows exogenously increased for some countries following the Iranian Revolution in 1979. Date: 2014 Downloads: (external link) Related works: Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text Persistent link: https://EconPapers.repec.org/RePEc:taf:applec:v:46:y:2014:i:4:p:359-373 Ordering information: This journal article can be ordered from DOI: 10.1080/00036846.2013.829207 Access Statistics for this article Applied Economics is currently edited by Anita Phillips More articles in Applied Economics from Taylor & Francis Journals |
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