This study tries to examine the effects of aid inflows on the government fiscal behavior, such as, taxation, borrowing and the allocation of other expenditure in Ethiopia by using a time series data from the period 1960-2012. There are five models, these models analyzed by applying the VECM and impulse response analysis. The results of the models indicate that an increase in grant results in an increase in the total tax revenue and total expenditure. But the disaggregation of tax revenue gives

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... different result on tax collection effort. The flow of grant has a tendency to decline direct tax collection effort. And also grant has a decrease effect on domestic borrowing, whereas the flow of grant encourages the government to increase both capital and recurrent expenditure. However, in relation to loan the result shows that loan has no effect on the fiscal components. Moreover, a model that includes ODA instead of either one of the two external financing components is estimated. The reason of incorporating ODA is that aid disbursed outside the budgetary framework can also affect government spending decisions. The results of an increase in ODA are similar to those of an increase in grants. Direct taxes and domestic borrowing fall, whereas recurrent expenditure rises. In addition, in the long run both capital expenditure and indirect tax affected by the flow of ODA in small amount. This might show ODA is more pro-consumption than investment and also aid and domestic borrowing are close substitutes.