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Fiscal Composition and Aid Effectiveness: A Political-Economy Model

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  • Mosley, Paul
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    Abstract

    In accounting for the rather gloomy trend of the aid effectiveness literature over the last few years, one explanatory strand has been fiscal, suggesting in particular that aid flows in weak states have tended to erode the taxbase and the structure of institutions. We pursue this idea, tracing the link from politics to domestic tax effort and then using the influence of this on expenditure to explain the leverage of aid. Thus, we argue that in the long run, tax effort determines the effectiveness of aid, and this relationship operates simultaneously in some countries with the negative link in the opposite direction, from aid to domestic tax effort, as observed by Bräutigam and Knack (2004) and others. We find that tax effort and the ability of the state to diversify its taxation structure are important determinants of long-term growth and aid effectiveness, and in our model, we find that overall aid effectiveness is, in a 3SLS model, weakly positive and significant, echoing the findings of Arndt, Jones and Tarp (2009) and Minoiu and Reddy (2010); however, these findings are not robust when retested using the GMMapproach favoured by the literature. A more robust finding, and a key message for policy, is that a broadening of the tax structure in low-income countries is crucial in order to enable those countries to escape from the .weak state . low tax trap., and to make aid more effective.

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    File URL: http://www.wider.unu.edu/stc/repec/pdfs/wp2012/wp2012-029.pdf
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    Bibliographic Info

    Paper provided by World Institute for Development Economic Research (UNU-WIDER) in its series Working Paper Series with number UNU-WIDER Research Paper WP2012/29.

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    Length: 19
    Date of creation: 2012
    Date of revision:
    Handle: RePEc:unu:wpaper:wp2012-29

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    Keywords: aid effectiveness; tax policy;

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    1. Mosley, Paul, 2012. "The Politics of Poverty Reduction," OUP Catalogue, Oxford University Press, number 9780199692125.
    2. Channing Arndt & Sam Jones & Finn Tarp, 2009. "Aid and Growth: Have We Come Full Circle?," Discussion Papers 09-22, University of Copenhagen. Department of Economics.
    3. Mosley, Paul & Hudson, John & Horrell, Sara, 1987. "Aid, the Public Sector and the Market in Less Developed Countries," Economic Journal, Royal Economic Society, vol. 97(387), pages 616-41, September.
    4. Hansen, Henrik & Tarp, Finn, 2001. "Aid and growth regressions," Journal of Development Economics, Elsevier, vol. 64(2), pages 547-570, April.
    5. David Fielding & George Mavrotas, 2008. "Aid Volatility and Donor-Recipient Characteristics in 'Difficult Partnership Countries'," Economica, London School of Economics and Political Science, vol. 75(299), pages 481-494, 08.
    6. Perotti, Roberto & Alesina, Alberto, 1996. "Income Distribution, Political Instability, and Investment," Scholarly Articles 4553018, Harvard University Department of Economics.
    7. Sanjay G. Reddy & Camelia Minoiu, 2006. "Development Aid and Economic Growth: A Positive Long-Run Relation," Working Papers 29, United Nations, Department of Economics and Social Affairs.
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