The paradox of tax exemptions of Official Development Assistance in developing countries.

Tax exemptions for foreign aid-funded projects have been the subject of international debate since the mid-2000s, their elimination being frequently discussed but never implemented. This issue has now returned to the fore. First, many developing countries have embarked on reforms in the areas of tax policy and administration with a view to improving the efficiency of their general tax system. These efforts have made tax systems more acceptable, eliminating one of the main justifications for aid-related tax exemptions. Second, the International Conference on Financing for Development held in Addis Ababa in August 2015 emphasised domestic resource mobilisation as the high-priority source of development finance. However, the broadening of tax base, which is synonymous with a more evenly spread tax burden, faces the proliferation of special tax arrangements, fuelled in part by the tax-exempt status of Official Development Assistance (ODA). Exemptions for project aid could represent as much as 2 percent to 3 percent of gross domestic product (GDP) in countries where tax revenues barely surpass 15 percent of GDP or, in the case of failed states, 10 percent of GDP or less. In addition to loss of tax revenue, tax exemptions for project aid have particularly damaging effects on the formalisation of the economies of recipient countries and on the efficiency of their tax and customs institutions. Moreover, systematic exemption reduces the credibility of the policies of donor countries and the consistency of their aid policy, which can directly support the budget of a developing country while demanding that its project aid be exempt from taxation. Last, the taxation of aid meets the commitment made by donors in the Paris Declaration on Aid Effectiveness (2005) to use recipient countries’ national public financial management systems.