Abstract

This paper explores how the wealthy's tax evasion behavior is shaped by the level of rule of law, and its consequences for fiscal capacity building. In contexts with lower respect for the rule of law and weaker property rights, the possibility of rulers' predatory behavior inclines wealth holders to shelter their wealth, decreasing tax compliance. Such wealth sheltering is especially common during wartime when rulers confiscate assets to fund the war. With wealth sheltering, it is unlikely that the rulers will invest in fiscal capacity building since there will be no sufficient assets to make such an investment optimal. Under stronger rule of law and property rights, the constraints on the rulers' predatory behavior provides higher security for wealth holders and makes them less likely to shelter wealth, bringing higher tax compliance. This compliance makes it more likely that rulers can increase fiscal revenues during war and therefore will be more likely to invest in fiscal capacity. Empirically, the paper uses an original dataset of Ottoman waqfs in modern-day Greece and Bulgaria between 1600 and 1912 in addition to annual Ottoman fiscal revenue data. Results indicate that wars increase wealth sheltering under weaker rule of law, while they do not under stronger rule of law. Furthermore, while wars do not increase fiscal revenues under weaker rule of law, they increase fiscal revenues under stronger rule of law. In other words, war does not make the state under weak rule of law, but does make the state under strong rule of law and security of property. The paper, thus, outlines a dilemma for the rulers: In order to be able to increase fiscal revenues and strengthen the state in the long term, they need to tie their own hands and forgo their predatory ability that can provide them revenues in the short term.