Elite Factions, Inequality, and Taxation

Abstract

This paper builds a theoretical model to highlight how inequality can increase local fiscal capacity. First, wealth distribution determines which sectors of the population bear the highest cost and benefit of taxation and, consequently, their willingness to comply with tax obligations. Furthermore, the concentration of wealth in the hands of a few can reduce the government's cost of raising an additional dollar of revenue. Using data from Colombia from 1920 to 1960, we show that places with higher economic inequality have higher tax revenues. We argue that wealthy local elites are more willing to comply with tax obligations if they benefit from large local public investments that increase their asset's value. Consistent with this idea, we also find that the relationship between inequality and taxation is higher when local elites belong to the ruling coalition, which allows them to allocate public spending on goods that further their own interests.