Tax reform, public revenue and public revenue instability in developing countries: Does development aid matter?

This paper addresses two main questions concerning the relationship between tax reform, development aid, public revenue and public revenue instability in developing countries. Tax reform involves here a change in the tax structure in favour of domestic public revenue and at the expense of international trade tax revenue. The analysis uses an unbalanced panel dataset of 95 developing countries over the period 1981-2015, and the two-step system Generalized Methods of Moments approach. Empirical findings show that tax reform exerts a positive and significant effect on tax revenue-to-GDP ratio, with the magnitude of this positive effect increasing as the amount of development aid flows that accrue to developing countries increases. In addition, while tax reform exerts a reducing effect on tax revenue instability, the magnitude of this reducing effect diminishes as the degree of development aid volatility increases. Specifically, beyond a certain level of development aid volatility, tax reform enhances tax revenue instability. Overall, these findings suggest that a rise in development aid flows to developing countries should be accompanied by a lower aid volatility so as to ensure that tax reform would induce higher tax revenue while concomitantly reducing tax revenue instability in recipient-countries.