Fiscal Capacity and Inequality: Evidence from Brazilian Municipalities

Abstract

We argue that wealthy elites in democracies can limit their taxes by constraining the fiscal capacity of the state. Corrupting local officials and undermining fiscal capacity are some of the mechanisms by which high-income earners can lower their own tax liabilities, even when voters favor higher de jure levels of taxation. The incentive to undermine fiscal capacity is especially compelling when inequality is high, as the median voter is likely to support higher progressive taxation and redistribution. Using data from over 5,500 Brazilian municipalities, we show that localities with higher levels of inequality accrue less revenue from local property taxes. These results are robust to estimating a number of cross-sectional models as well as panel models with time and municipal fixed effects. Moreover, we show that municipalities with high levels of inequality are less likely to apply to a federal grant program to increase their capacity to collect taxes.