Protection Not for Sale, But for Tax Compliance

How do rulers raise taxes when the fiscal capacity of the state is weak? I argue that, in conditions of low fiscal capacity, rulers might secure high tax yields by granting protection from competition to key domestic producers. I offer qualitative evidence of this exchange in the developing world today and test the theory against a sample of thirty-two developing states in Latin American, Eastern Europe, and the former Soviet Union circa 2005. Results indicate that, conditional on poor fiscal capacity, declining industries pay higher taxes (or evade less) if governments grant them tariff protection from international competitors. The results add to recent scholarship that studies the conditions under which entry barriers—which are otherwise inefficient institutions—result in second-best solutions for states whose capabilities are still consolidating. My findings suggest that trade protection does not always stem from rent-seeking by government. This article therefore offers a new, alternative hypothesis to canonical models in international political economy.