Foreign Aid and Revenue: Still a Crowding Out Effect?

Abstract

This paper reexamines the relationship between aid and domestic tax revenues using a more recent and comprehensive dataset covering 118 countries for the period 1980–2009. Overall, our results support earlier findings of a negative association between net Official Development Assistance (ODA) and domestic tax revenues, but this relationship appears to have weakened in reflection of greater efforts at mobilizing domestic revenues in many countries. The composition of net ODA matters: ODA grants are associated with lower revenues, while ODA loans are not. The paper further finds that net ODA and grants are negatively associated with VAT, excise and income tax revenues, but have a positive relationship with trade taxes. Aid has a particularly strong negative effect on domestic tax revenues in low-income countries and incountries with relatively weak institutions.