Fiscal Capacity and Aid Allocation: Domestic Resource Mobilization and Foreign Aid in Developing Countries

Abstract

This paper is part of a the UNRISD project on The Politics of Domestic Resource Mobilization (UNRISD 2012). Its specific contribution is with regards to the interaction between fiscal performance and donor aid allocation in developing countries. While several studies have examined whether aid affects fiscal performance, there has been no systematic study of whether fiscal ca pacity and performance in developing countries has any impact on donor aid allocation decisions. We argue that the latter is an important issue given that domestic resource mobilization (DRM) is being increasingly recognized as an important component of fi nancing for development, and that some donors are beginning to pay more attention to taxation and fiscal capacity. After reviewing the fiscal performance and aid allocation literature, we discuss the results of a large N -analysis for the period 1992-2010 t hat augments a standard aid allocation model with fiscal variables. This preliminary analysis of overall bilateral and multilateral aid allocation leads us to conclude that there is hardly any correlation between overall aid and fiscal performance and capa city. We then complement this analysis by discussing the recent fiscal performance data and donor involvement in taxation and public financial management (PFM) in four case study countries. These case studies allow us to examine donor-recipient relationships. Specifically, we calculate a tax effort index for recipient countries over the period 1990-2012 and examine trends in various fiscal performance metrics. We also highlight which donors are present in the case study countries, and what their perceptions of fiscal performance in these countries are. Our analysis shows that there are important gaps in terms of donors delivering on their commitments to align with recipient country priorities and providing aid through country PFM systems.