Financing the State: Inequality and Fiscal Capacity in Uneven Territories

Abstract

This dissertation seeks to understand the origins of the state's uneven territorial reach. I focus on both the conditions that produced the initial divergence between strong and weak local institutions, and on the persistence of this variation over time. Using an original dataset measuring the ability of Brazilian municipalities to tax, I trace the roots of current differences in local state capacity to the early 20th century. During Brazil's First Republic, landowning elites sought to strengthen local taxation, despite the risks this strategy entailed. In fact, their ability to profit from strong fiscal institutions increased with the level of local landholding inequality. Hence, unequal municipalities developed more robust fiscal apparatuses. In these settings, the costs of building strong extractive institutions were broadly shared -- through a heavy reliance on indirect taxes -- while the gains they generated were concentrated -- via spending on targeted rather than broad public goods.

Two specific features of the Republican period made landholding inequality consequential for local outcomes. First, a high degree of decentralization gave local actors more room for maneuver to influence municipal institutions. Second, limited franchise and reduced economic diversification created an environment of low political uncertainty. Yet, these conditions were not uniformly present across the territory. The extreme federalism mandated by the 1891 Constitution was accompanied by the emergence of distinct party systems across states. In those regions where factional politics prevailed, elite groups could not effectively coordinate to minimize opportunistic behavior by rivals and were, thus, less eager to expand taxation. In other states, hegemonic parties were able to guarantee a predictable political environment that obviated the need for contending factions to refrain from strengthening the state.

That land inequality led to more efficient local taxation in the past, however, does not elucidate whether it encouraged a positive institutional trajectory, or constituted a short-lived episode of predatory extraction. I show that past land inequality patterns ceased to affect local institutions over time. Nonetheless, historically capable local administrations continued to outperform their neighbors in terms of taxation and, eventually, in the provision of broad public goods.