Determinants of Fiscal Capacity:history, geography or politics?

Antonio Savoia, with R. Ricciuti and Kunal sen

Effective States and Inclusive Development (ESID) research centre University of Manchester

www.effective-states.org

DSA 2014 Conference, London

This paper…

• Looks at long-run factors affecting state capacity

• Asking whether historical, geographical or political factors matter

• Using a new database, capturing better the concept of fiscal capacity

• Evidence that the states are more effective at raising revenues when the have stronger systems of checks and balances

1. Context and motivation

• Governance matters! • State capacity as an ingredient for effective

governance. – Focus on property rights, but recent research

looks at state institutions… • Gap in empirical research on the determinants

of effective states; no systematic analysis See Savoia and Sen 2014 review Journal of Economic Surveys

What is state capacity?

• Definition: institutional capability of the state to carry out various policies that deliver benefits and services to households and firms (Besley and Persson, 2011, p.2).

• In practice we have a series of capacities, according to the functions states perform (e.g., legal, infrastructural, military)

• However, they tend to move together– Have strong complementarities and common

determinants

What is fiscal capacity?

• Fiscal capacity: the state’s ability to raise revenues from taxes

• Shown to be key determinant of long-run economic development (see Dincecco and Katz 2014 EJ)

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Which forces shape state capacity?

• Historical– Incidence of external conflict– Length of statehood– Legal origins

• Geographical– Natural resources abundance – Population density

• Political economy– Executive power subject to checks and balance

2. Fiscal capacity: data

• Exploit a recent database: Public Expenditure and Financial Accountability (PEFA)

• Dependent variables (coded on 0-3 scale): – “Clarity and comprehensiveness of tax liabilities” – “Existence and functioning of a tax appeals

mechanism”– “Effectiveness in collection of tax payments” – “Aggregate revenue out-turn compared to original

approved budget”

Explanatory variables

• Proportion years in external conflict• Urban population (% of total)• State antiquity index • Constraints on the executive (Polity IV)• Total natural resource rents (% of GDP) • Controls: legal origins, ethnic fractionalisation,

inequality, internal conflict, aid, regional dummies

3. Methods

• Cross-section regressions• Sample: ranging from 63 to 40 developing

economies• Identification issues: instrumental variables

methods to account the potential endogeneity of political systems

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4. Results and findings

• There is limited evidence in favour of the ‘historical variables’: stronger for length of statehood than incidence of external conflict.

• ‘Geographical variables’ receive inconsistent support.

• The level of constraints on the executive seems to be the most robust predictor of fiscal capacity.

Implications

• Evidence supporting the importance of political institutions.

• Good news in policy terms?– Yes: unlike history or geography, institutions results from

collective choices – Not quite: institutional reforms are not an easy task (e.g.,

role of elites)

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State capacities

• Bureaucratic and administrative • Legal • Fiscal • Infrastructural • Military

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Besley and Persson on fiscal and legal capacity

• Fiscal and legal capacity as a joint investment problem

• Idea of complementarity• Prediction: fiscal and legal capacities have

common determinants– factors that raise fiscal capacity are expected to

raise also legal capacity and vice versa– Three types states: common-interest states;

redistributive state; weak state

Theory of fiscal and legal capacity