Historical Path Dependence in Intergovernmental Tax Arrangements

Abstract

This paper investigates the role of deep historical elements in shaping intergovernmental tax arrangements as an alternative to the various modern-day features suggested by economic theories. We connect historical elements and key explanatory factors embedded in ethno-cultural diversity and geography to new indicators measuring the taxing rights of sub-national governments in many countries. We estimate the effects of economically relevant and historical institutional variables on the current design of the multi-layer tax structure across more than 70 countries in Africa, the Middle East, and Asia. The results confirm the relevance of the historical variables. Sub-national governments in countries with a higher degree of pre-colonial state centralization tend to have greater discretionary power over tax matters today. The path out of colonization also matters: countries that have experienced a violent independence movement tend to have a more centralized tax structure. Contrary to the conventional view, ethno-cultural diversity falls short in explaining multi-layer tax arrangements. However, the standard economic theories are not all irrelevant: country size and terrain ruggedness tend to imply greater decentralization of tax-related decisions. The results are robust to an extensive set of control variables and a range of IV-GMM estimations using ecological diversity, the Tsetse suitability index, and Neolithic transition timing as instrumental variables for pre-colonial centralization.