Protection Not for Sale, But for Tax Compliance

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Authors Didac Queralt
Paper Category
Paper Abstract This paper presents a theory of endogenous market protection and state capacity. Based on historical accounts of pre-modern Europe, Latin America and East Asia, I claim that rulers might strategically raise entry barriers to induce higher tax compliance by key domestic producers. A game-theoretical analysis proves that Protection for Tax Compliance, as I refer to this exchange, is not only revenue-effective but welfare-maximizing if the initial stock of fiscal capacity is sufficiently low and policy capture by interest groups is limited. The theoretical prediction, which challenges the standard assumption that protection is always for sale, is tested against a sample of 32 developing states in Latin American and Eastern Europe circa 2005. The empirical analysis indicates that, conditional on low fiscal capacity, declining industries pay higher taxes (or evade less) if they are granted tariff protection from international competitors. The results add to recent scholarship studying the conditions under which entry barriers, otherwise inefficient institutions, result in second-best solutions for states whose capabilities are still consolidating.
Date of publication 2017
Code Programming Language R

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