Democracy, urbanization, and tax revenue

Abstract

During the last two centuries, taxation has not only increased dramatically in level and volume; its structure has also changed: from a heavy reliance on customs revenue in the early nineteenth century to a stronger emphasis on income taxation in the twentieth. A common explanation for this development is the spread of democracy, which supposedly increases redistribution and the size of government. This paper argues that the effect of democratization on taxation depends on the distribution of tax preferences in society. These preferences are not uniform: rural farmers prefer different policies than urban workers. Thus, the impact of democratization varies depending on the urbanization rate. The paper uses a novel dataset providing data on government tax revenue in thirty-one countries in Western Europe, the Americas, Australia, New Zealand, and Japan—from as far back as 1800 up to the present day—in order to evaluate the conditional impact of democratization on tax structure. The results show that democracy decreases property taxes in rural countries but instead increases income taxes and decreases excise and consumption taxes in more urbanized states. These results are robust to different estimation methods, a number of control variables, such as interstate warfare, and to alternative measurements of democracy.