Loans and Taxes: How Bilateral Loans shape Revenue Composition

Bilateral loans must be repaid, even when offered on favorable terms. This compels governments in developing countries to raise tax revenues. We argue that the identity of the creditor influences how politicians increase these revenues. Loans from OECD countries are typically tied to conditions promoting foreign direct investment and expanding domestic production, incentivizing politicians to raise tax revenues from corporate income and profits. In contrast, loans from BRIC countries are often linked to trade-related infrastructure and natural resource exports, encouraging governments to expand tax revenues from international trade. We test these claims using a two-step empirical strategy. First, we trace the causal process through case studies of Tunisia and Ghana. Second, we generalize our findings with a panel dataset of 80 developing countries from 1972 to 2015, employing a statistical model that accounts for the endogeneity across different sources of tax revenue. Our findings provide strong support for the argument that creditor identity shapes politicians' tax policy choices.