Abstract
This paper assesses the impact of aid on tax revenue effort in the context of a fragile state, using the case of the Comoros. The paper estimates a fiscal response model within a cointegrated vector autoregressive framework with annual data for the Comoros’ post-independence period (1984-2017). The data suggest that grants and tax revenue in the Comoros had a significant negative relationship in the long run that remained stable throughout the post-independence period. Grants are a politically less costly source of finance, reducing the urgency of fragile states’ fiscal planners to expend their reduced political capital and administrative capacity on tax collection reforms. This effect may be amplified by the large one-off budget support grants, which represent a windfall of resources to the Comoros from bilateral partners, which often may have stopped tax reform initiatives. Although the paper does not suggest a decrease in aid to fragile states, as aid constitutes an essential support for these countries, being aware of this historically negative relationship is an important step to ensure that the government’s tax revenue efforts do not slow down following, for instance, large one-off unconditional budgetary support. In addition, the paper argues that prioritizing conditional aid, focusing on aid effectiveness, and engaging more resources for capacity-building tax revenue projects and technical assistance could increase the impact of donors’ interventions.
Highlights
The fiscal impact of aid has become one of the most critical issues related to aid effectiveness (Bwire, Lloyd and Morrissey, 2017; McGillivray and Morrissey, 2004)
Fitting the cointegrating Vector Error Correction Mechanism (VECM) entails specifying the number of lags to be included, the latter of which is determined by minimizing information criteria
Including pp=4 is unrealistic given that the impact of grants elicits quick adjustment dynamics in the domestic fiscal variables. This points to pp=2 being the most preferable choice, consistent with the standard lag-length used in estimating fiscal response model (FRM) in the literature
Summary
The fiscal impact of aid has become one of the most critical issues related to aid effectiveness (Bwire, Lloyd and Morrissey, 2017; McGillivray and Morrissey, 2004). A sizable portion of aid flows passes through governments’ budgets, directly influencing fiscal aggregates such as tax revenue and public expenditure. Any macroeconomic impact of aid is linked to the behavior of the public sector, in particular, how decisions on taxation and expenditure are affected by aid flows (Morrissey, 2015a). Aid can decrease the country’s tax effort if it is viewed by recipients as a politically cheaper source of revenue. Aid can raise tax revenues if it strengthens revenue administration or supports tax policy reform (Morrissey, 2015b; Morrissey and Torrance, 2015; Mascagni and Timmis, 2017). This paper looks at the fiscal impact of aid in the context of a fragile state, focusing on the Comoros
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