Building fiscal capacity in developing countries: Evidence on the role of information technology

Limited fiscal capacity of states has received increased attention as an important constraint to economic development. Having an effective tax system requires a vast administrative infrastructure capable of gathering, analyzing, and monitoring earnings information of a large number of taxpayers—a capacity that many developing countries tend to lack. Thus, the advent of electronic systems has attracted governments in many developing countries as a relatively cheap alternative for monitoring earnings information and improving fiscal capacity. We document the first empirical evidence from Ethiopia where there has been a recent surge in the use of electronic sales register machines (ESRMs). Using a unique large-scale administrative dataset covering all business taxpayers and applying matching difference-in-difference method to account for possible bias that may arise due to selection into ESRM adoption, we find that tax payments by firms increase in the aftermath of the ESRM adoption. We also find a positive effect on employment and no effect on net entry, suggesting that increased tax payments by registered taxpayers occurred without erosion of the tax base.