Do output contractions cause investment in fiscal capacity?

Abstract

This paper shows that an economic slump can induce a government to invest in fiscal capacity. Large negative income shocks stress the revenue raising capability of narrow tax bases, Making an increase in tax base breadth desirable relative to its fixed implementation cost. A broader tax base enables revenue to be raised at lower tax rates, which reduces the efficiency cost of taxation. The behavior of U.S. state governments during the Great Depression supports the model: states experiencing larger than average negative income shocks were more likely to adopt a retail sales tax than were states experiencing smaller than average income shocks. Show more