The dynamic effects of aid and taxes on government spending

Abrams M. E. Tagem ()
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Abrams M. E. Tagem: UNU-WIDER

International Tax and Public Finance, 2023, vol. 30, issue 6, No 8, 1656-1687

Abstract: Abstract This paper examines the impact of foreign aid and taxes on government spending for 67 developing countries during 1980–2013 using dynamic heterogeneous (panel) time-series techniques. We find that spending, aid and tax ratios comprise an equilibrium (cointegrated) relation. On average, the aid coefficients (and marginal impacts) are positive but smaller than the tax coefficients, indicating that in the long-run and short-run taxes have a stronger association with expenditures than aid. Central to this heterogeneous relationship is the political calculus between aid and tax—measured according to accountability and bureaucratic costs—whereby recipients offset the political costs of raising taxes against the political costs of receiving more aid. Once measures of political costs are incorporated into the analysis, we find the political costs of aid to be higher than those of tax, reinforcing the primary assertion that for spending, taxes are more important than aid. Countries with higher political costs of aid typically show no aid-spending relationship, while those with lower political costs of aid tend to show an aid-spending relationship. The findings are largely when replicated once we split total spending into capital and consumption spending.

Keywords: Aid; Tax revenue; Political calculus; Nonstationary panel econometrics (search for similar items in EconPapers)
JEL-codes: C23 E62 F35 (search for similar items in EconPapers)
Date: 2023
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DOI: 10.1007/s10797-022-09763-9

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