The Effects of Aid on Fiscal Capacity: An econometric analysis on African countries (1960-2015)

Abstract: Low tax revenues in many African countries are hindering sustained economic development and aid could have an inhibiting effect on the development of fiscal capacity. This paper will use newly published high-quality data on tax revenues to dive deeper into the effects of aid on hard-to-collect taxes in Africa between 1960-2015. Previous aid literature has mostly focused on short-term effects on revenue collection but by looking at fiscal capacity this paper is able to contribute to the literature on the effects of aid and its components on more long-term institutional development. Using a fixed effects panel regression model, the results of the analysis show that aid has an overall positive effect on a country’s fiscal capacity. The results provide further evidence on the larger positive effects of loans on fiscal capacity compared to grants. Furthermore, the paper presents weak evidence of improvements in the effects of aid on fiscal capacity. The paper argues that aid has not created dependencies in Africa by undermining fiscal capacity development.