Is There a Fiscal Resource Curse? Resource Rents, Fiscal Capacity and Political Institutions

Abstract

While several studies have focused on the effect of natural resources on economic development, less attention has been paid to their effects on other development outcomes. We contribute to this literature by studying the impact of resource rents on fiscal capacity, i.e., the ability of states to raise revenues from broad tax bases. We posit that natural resource rents reduce the incentives to invest in fiscal capacity. However, political institutions that limit the power of the executive, by reducing rulers’ discretion over the use of resource revenues, may mitigate, neutralise or reverse such negative effect. We provide empirical support for this hypothesis using a recently constructed data set on non-resource taxes and panel methods for 98 developing countries covering the period 1981-2011. Moreover, we show that the effect of resource rents is likely to work mainly through institutions that make the tax system accountable and transparent to citizens. Our findings imply that it is possible to develop both fiscal capacity and the natural resources sector, without any trade-off. Whether a fiscal resource curse exists or not is a question of what type of political institutions countries have adopted before they became resource-rich.