Tax Aid, Foreign-Induced Fiscal Capacity, and Capital Flight

• In Event: Consequences of Economic Crisis

Abstract

As bilateral and multilateral donors providing numerous tax aid to developing countries to enhance their revenue-raising capacity, the effect of such tax aid on domestic revenue is yet mixed. Moreover, recent studies have found that tax aids actually lead to decreased personal income tax revenue (Seelkopf and Bastiaens 2000). Why? In this paper, I argue that wealthy individuals and corporates, in anticipating the more stringent tax collection enforcement due to tax aids, shift their otherwise taxable wealth to offshore financial centers (OFCs) to avoid paying taxes. Using project-level data on tax aids and bilateral-level cross-border deposits data, I find supportive evidence to the argument. The findings indicate that tax aid leads to an increasing amount of deposits in OFCs, but only in the short term. This study shed light on the unexpected consequences of foreign-induced fiscal capacity in the context of the developing world.

Author

• Jing Qian, Princeton University