State Capacity, Institutions and Growth: Taxing for Takeoff—Revisiting the Tax Tipping Point

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Can simply exceeding a critical tax-to-GDP threshold bring about an accelerated trajectory of economic growth and development in a country? We conduct new event studies and exploit a richer dataset to revisit Gaspar, Jaramillo and Wingender's 2016 "tax tipping point" result. Both with their regression discontinuity approach and a dynamic difference-in-differences estimation, we find that cumulative growth over 10 years increases by 10 percentage points when a country's tax-to-GDP ratio increases above a 10 percent threshold. Further, we show that crossing the threshold coincides with the beginning of significant improvements in measures of a country's financial development, government effectiveness, legal framework, and governance. Event studies additionally reveal that only transformational episodes of tax increases above the threshold deliver these gains: episodic crossings that fail to bring tax revenues durably above the threshold and that don't coincide with improvements in financial development and government effectiveness yield fleeting gains. Our results suggest that a minimal tax capacity is necessary for growth but emphasize that only a sustained tax increase associated with other developmental progress is sufficient.

Subject: Financial markets, Financial sector development, Revenue administration

Keywords: Development, Event Study, Financial sector development, Income per Capita, Multiple Equilibria, Taxation