Aiding Dependency: a Cross-National Analysis of Foreign Aid and Tax Compliance

This paper argues that foreign aid undermines tax compliance, and examines three causal mechanisms that may undergird this relationship: By leading the recipient state to under-invest in tax enforcement, substituting for the state in terms of service provision, or reducing state legitimacy. To test these arguments, the paper takes advantage of cross-national surveys on individual tax compliance. The results suggest that higher levels of foreign aid are associated with higher levels of refusals to pay taxes. The paper finds evidence that the causal mechanism is aid leading the state to reduce its enforcement of taxation, but not through the substitution of state services or decreasing state legitimacy. The results suggest that aid can have counter-productive effects for the long-term development of recipient countries by lowering the state’s enforcement of taxation, but not by weakening the relationship between state and society.