Background: Sovereign defaults and fluctuating tax policies still haunt many emerging and low-income states, largely because of governance inadequacy. Although tax-smoothing rationale suggests governments would borrow in recessions and repay in expansions to avoid fluctuating tax rates, weak institutions and corruption often undermine this mechanism, resulting in higher default and sudden fiscal adjustments. Objectives: The main goal of this study is to: (a) evaluate the quantitative effects of perceived corruption and institutional quality on sovereign default probabilities, (b) examine both these governance measures on the volatility of tax to GDP ratio, and (c) consider the ability of strong institutions to offset the negative fiscal implications arising from high debt straps. Method: We augment a standard sovereign-debt model by introducing a “governance penalty” variable that increases the cost of borrowing when corruption is high. Empirically, we test using panel data of 75 emerging and low-income countries from 1995 and 2020. We estimate default risk with panel logistic regressions with fixed effects and tax volatility with fixed effects regressions on the standard deviation of the difference of tax-to-GDP ratios. Interaction terms examine if institutional quality moderates the destabilizing consequences. Results: Our empirical results indicate that a one-point deterioration of the Corruption Perceptions Index leads to a 7–8% increase in the likelihood of a sovereign default. Greater institutional quality reduces default risk by about 5 % per unit enhancement. Weak governance is also associated with significantly higher tax volatility, after controlling for the level of the debt and macroeconomic factors. Interaction effects reveal that better institutional quality softens the public debt budget impact, stabilizes the tax paths, and reduces the likelihood of default. Conclusion: Our findings emphasize governance as a core principle of debt sustainability and fiscal stability. Anti-corruption reforms (including, eg, electronic procurement systems, open budgeting, and increased judicial independence) reduce the risk premium, stabilise revenue, and enhance the country’s resistance to shocks. In our lending and rating frameworks, the governance benchmarks must be embedded into this to convert such episodic crises into opportunities for sustainable, broad-based growth.