Democracy, State Capacity and Public Finance

The purpose of this paper is to consider the determinants of state capacity investments and public finance in societies with different intensities of democracy. Specifically, we consider the implications of political (dis)parity between the political parties as well as voter groups for state capacity investments, public goods provision, preferential tax policies between the elites and citizens, and the ability of the incumbent government to accrue political rents. The paper provides a unified framework to study the direct and indirect effects of democracy by combining state capacity investment and probabilistic voting. Paradoxically, while stronger electoral contestability leads to higher public good provision and lower political rents, it deteriorates the incumbent’s incentive to invest in state capacity. Similarly, when increased political inclusivity between the voters leads to higher public good provision and lower political rents, it will have a negative effect on state capacity. Conversely, if the effect of inclusivity on state capacity investment is positive, then public good provision will decline