Not Just About the Money: Rethinking the Role of Taxation in State Capacity

• In Event: Taxation and State Capacity: Insights from the Developing World

Abstract

Scholars has attributed taxation as a cornerstone of state capacity, primarily because it finances public goods and services as well as enhances bureaucratic competence. We contend that taxation plays another important role by incentivizing local elites to assist the state to maintain local political order. Specifically, direct taxation offers the opportunity to allow local elites interact with citizens, and the design of taxation system provide incentives, such as fiscal autonomy, to local elites, who assist the state to carry out policies and maintain local political order. We test our argument by exploring the exogenous shock on tax reduction due to the abolition of agricultural tax in early 2000s in China. Using a panel dataset containing nationally representative villages between 2000 and 2007, we first show that greater tax reduction surprisingly increased tax noncompliance and social unrest in rural China. These results are robust to both DID and IV model specifications. Investigating the underlying mechanisms, we demonstrate that the negative effects were not primarily the results of declining fiscal capacity and bureaucratic competence but were driven by weakening fiscal autonomy that dis-incentivizes village elites to resolve local political order.

Authors

• Xiaobo Lu, University of Texas at Austin

• Linke Hou, Shandong University

• Mingxing Liu, Peking University