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Would better state institutions increase tax collection, or would higher tax collection help improve state institutions? In the absence of conclusive guidance from theory, this paper searches for an empirical answer to this question, using a panel dataset covering 110 non-resource-rich countries from 1996 to 2017. Employing a panel vector error correction model, the paper finds that tax capacity and state institutions cause and reinforce each other for a wide range of country groups. The bi-directional causality results suggest that developing tax capacity and building state institutions need to go hand in hand for best results, particularly in developing countries. Based on the impulse response analyses, the paper also finds that the causal effects in advanced economies are generally low in both directions, while in developing countries, both tax capacity and institutions shocks have larger positive impacts on institutions and tax capacity, respectively.

Econometrics --- Public Finance --- Taxation --- Structure, Scope, and Performance of Government --- Tax Evasion and Avoidance --- 'Panel Data Models --- Spatio-temporal Models' --- Taxation, Subsidies, and Revenue: General --- Multiple or Simultaneous Equation Models --- Multiple Variables: General --- Public finance & taxation --- Econometrics & economic statistics --- Revenue administration --- Vector error correction models --- Subnational tax --- Revenue Administration Fiscal Information Tool (RA-FIT) --- Revenue --- Econometric models

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High persistence of state fragility (a fragility trap) suggests the presence of substantial benefits from avoiding a fall into fragility and considerable hurdles to successful exit from fragility. This paper empirically examines the factors that affect the turning points of entering and exiting from state fragility by employing three different approaches: an event study, the synthetic control method, and a logit model. We find that avoiding economic contraction is critical to prevent a country on the brink of fragility from falling into fragility (e.g., among near fragile countries, the probability of entering fragility would rise by 40 percentage points should real GDP per capita growth decline from +2.5 percent to -2.5 percent). Also, strengthening government effectiveness together with increasing political inclusion and maintaining robust economic activity should help make exit from fragility more successful and sustainable. In the current environment (the COVID-19 crisis and its aftermath), the findings suggest the importance of providing well-directed fiscal stimulus with sufficient financing, (subject to appropriate governance safeguards and well-designed policies), and protecting critical socio-economic spending to keep vulnerable countries away from being caught in a fragility trap.

Macroeconomics --- Economics: General --- International Economics --- Econometrics --- Public Finance --- Foreign Exchange --- Informal Economy --- Underground Econom --- Discrete Regression and Qualitative Choice Models --- Discrete Regressors --- Proportions --- National Government Expenditures and Education --- National Government Expenditures and Health --- National Government Expenditures and Related Policies: General --- Aggregate Factor Income Distribution --- Economic & financial crises & disasters --- Economics of specific sectors --- Econometrics & economic statistics --- Public finance & taxation --- Financial crises --- Economic sectors --- Logit models --- Econometric analysis --- Education spending --- Expenditure --- Health care spending --- Income --- National accounts --- Currency crises --- Informal sector --- Economics --- Econometric models --- Expenditures, Public