Does aid fragmentation affect tax revenue dynamics in developing countries? Observations with new tax data

Abstract

There exists a burgeoning empirical literature on the impact of aid fragmentation on development outcomes in aid-receiving countries, with it being widely recognized that aid fragmentation is deleterious. This paper adds to the existing literature by estimating the impact of aid fragmentation on tax revenue mobilization in developing countries. Drawing on the popular system generalized method of moments technique to counter endogeneity issues, this study focuses on a sample of 90 developing countries covering the period from 2000 to 2020. We show that aid fragmentation, measured by the Herfindahl index, has a significant negative impact on recipient countries’ tax revenue ratios, an impact that is not mitigated by the level of institutional quality. The paper also explores the impact of aid fragmentation on tax structure and finds convincing evidence that direct taxes, particularly corporate income taxes, are the most affected. Value-added tax is the only indirect tax affected by aid fragmentation.