The Legacy of War on Fiscal Capacity Didac Queralt∗ October 29, 2018 Abstract This manuscript revisits the relationship between war and state-making in modern times by focusing on types of war finance. Tax-financed war exerts lasting effects on state capacity because new taxes require enhancements of the state apparatus and complementary fiscal innovations. Loan-financed war may not contribute to long-term state capacity because countries might default once the war ends, preempting any persistent fiscal effect. I advance two mechanisms of transmission of war effects: one being political—tax-financed war transforms taxation into a nonzero-sum game|, the other bureaucratic. To address concerns of endogeneity in access to war participation and war finance, I exploit unanticipated, historical crashes in international financial markets, which temporarily dried up capital flows around the globe and precluded warring states from borrowing irrespective of their (un)observed characteristics. Results suggest that the advent of a genuinely global capital market in the early nineteenth century undermined the association between war and state making. ∗Yale University, Political Science;
[email protected] 1 1 Introduction War, although devastating, offers a matchless opportunity to transform the state. The magnitude of resources a country must amass to finance the means of war offers rulers the incentives to invest in state making while reducing domestic resistance to taxation. War clears the path to fiscal centralization (Dincecco, 2011), the professionalization of the tax administration (Ardant, 1975), and the adoption of new taxes|from excises (Brewer, 1988) to progressive income taxes (Scheve and Stasavage, 2010). Fiscal innovations are often ac- companied by complementary organizations, including treasuries and central banks (O'Brien, 2001), and improved budgeting technologies (Dincecco, 2011).