Aid modalities and budgetary response: Panel data evidence

We investigate the budgetary effects of project and program financing on the behavior of recipient governments. For this purpose, we developed a simple fiscal response model. The solution of the model is then tested using panel data techniques for a relatively large sample of 106 aid-recipient countries spanning the period 1970-2001. With respect to public expenditure, our results suggest that the impacts of project aid and financial program aid on total expenditure are positive and statistically significant. In terms of the composition of total expenditure, we find that project aid flows are associated with increases in capital expenditure while financial program aid is associated with an increase in government consumption. Turning to the revenue side we found no evidence that aid flows, project or financial program aid, are associated with a reduction in taxation effort. The evidence also shows that project aid flows are associated with an increase in trade tax.