Economics Working Paper Series Volume 73

The relation between aid and tax has been largely debated in the literature, given its far-reaching consequences: the presence of a crowding-out effect of aid on domestic revenue would seriously impair the sustainability of the development process. This paper explores this relation by adopting a case-study approach, which overcomes some of the common limits of the cross-country literature. I use time series data for Ethiopia for 1960-2009, a longer time series than most country studies of this kind. The estimation is based on an error correction model that allows separating long-run equilibrium relations and short-run dynamics. The analysis shows that both foreign grants and loans have a positive relation with tax revenue in Ethiopia. This effect seems to be robust to endogeneity and to structural breaks, although clearly establishing causality remains a challenge. The results show that aid has a beneficial effect on tax revenue, which may be due to its role in supporting fiscal reforms and improvements in tax administration.


Giulia Mascagni

Giulia Mascagni is a Research Fellow at the Institute of Development Studies and Research Director of the ICTD. Her main area of work is taxation, but she also has research interest in public finance, evaluation of public policy, and aid effectiveness. She is an economist by training, holding a PhD in Economics from the University of Sussex. Her main geographical interest lies in African countries, with a particular focus on Ethiopia and Rwanda.