New Evidence on Tax-Aid Nexus

Abstract: Effective tax systems play a key role in self-sustained economic growth. Where foreign aid can provide much needed funds for less developed countries, it may also increase aid dependency if the country does not simultaneously improve its taxing capacity. This thesis is empirically investigating the relationship of foreign aid and tax revenue mobilization in a panel of 53 African countries during 1980-2018. The instrumental variable approach yields a positive short run effect for total ODA and taxes. This gives a positive outlook of taxing and development and reduces stress over fiduciary risks, moral hazard and aid dependency often attributed to foreign aid. Additionally, the thesis finds a negative association with taxes and technical assistance, i.e., professional services often included in aid that aim to improve the fiscal management of the aid funds. Consequently, aid donors should develop better ways to offer technical assistance that is better aligned with the objectives of the recipient governments. Concessional loans, often cited as a preferred aid modality due to lower fiduciary risks, do not show any statistically significant association with taxes.