Foreign AID, public spending and tax revenue Determinants Causal relationships in Sub-Saharan Africa

The purpose of this to examine ne three related issues. First, the determinants of foreign aid, second, the effect of foreign aid on both government expenditure and revenue and, third, the causal relationship between foreign aid and expenditure and foreign aid and tax revenue. The study uses OLS, static analysis and system GMM methodologies and panel data considering 1980 to 2004 period. The evidence suggests that foreign aid in SSA is determined by population density, domestic credit, freedom, literacy rate, gross national income per capita, and that Britain and France are highly probable to offer aid to countries previously colonized by them. While aid is found to have a positive impact on expenditure, it has a negative correlation with revenue. Finally, it is determined that changes in foreign aid cause changes in both expenditure and revenue without reverse causation. It is also evident that the magnitude of coefficients increases as one moves from OLS to static analysis and system GMM, signifying that the use of panel data assists in obtaining consistent estimates in the presence of end ogeneity bias, omitted variables, measurement error and to a small extent unit root effect problems. Finally, the paper offers policy implications on how to attract more aid to the region. Democratic tendencies are necessary to promote and attract aid, improve expenditure and revenues. Policy makers should be aware that exogenous change in foreign aid affects both revenue and government without reverse causation.