Post on 12-Apr-2017
The Political Economy of Tariff Revenue Dependence:
Does Electoral District Magnitude Matter?
Objective. This paper investigates whether electoral district magnitude in democratic developing countries
influences government dependence on trade tax revenue through the aggregation of voters’ preferences over
taxation. These preferences over the use of different tax instruments tend to vary with voters’ income levels.
Method. The author uses fixed effects panel regression, with the dependent variable being tariff share of
government revenue. Results and conclusion. This study finds that higher electoral district magnitudes are
significantly associated with lower tariff revenue shares, controlling for confounders and alternative factors. It
also finds that income inequality moderates the negative association between district magnitude and tariff
revenue share.
1. Introduction
Tariffs are an important source of government revenue. Developing countries, in particular, rely more on tariff
revenues than their developed counterparts (Tanzi, 1987; Hitiris, 1990; Kubota, 2005). In fact, Tanzi (1987)
found that in developing countries, import duties account for 25% of total tax revenue, making them ‘by far the
single most important revenue source’. One proposed reason for this is that developing country bureaucracies
are too ineffective to collect other forms of taxes (Aizenman, 1987; Gardner and Kimbrough, 1992; Khattry and
Rao, 2002). On the other hand, political economy suggests that democratisation drives tariff revenue
dependence up in developing countries by strengthening the influence of the poor median voter, who imports
few high-quality goods and is less sensitive to hikes in tariffs than other taxes (Moutos, 2001; Adam, 2009).
However, existing research has yet to consider whether democracies with different electoral systems will
produce the same equilibrium level of tariff revenue dependence. Electoral systems with larger district
magnitudes, which allow representation of more different voters than just the poor median voter, might be
expected to produce lower tariff revenue shares in equilibrium. Thus, this paper investigates the effect of
varying electoral district magnitude on tariff revenue dependence in developing countries. It finds significant
evidence of a negative association between district magnitude and tariff revenue share in developing countries,
particularly when the effect of income inequality and its interaction with district magnitude is accounted for.
This study endeavours to provide a better understanding of the challenges faced by governments in developing
countries when they undertake trade liberalisation policies and are constrained by fiscal needs.
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2. Existing Literature
2.1 Explaining tariff revenue dependence using bureaucratic capabilities
A longstanding explanation for developing countries’ significant tariff revenue shares involves weak
administrative and bureaucratic capabilities, which prevent governments in developing countries from
effectively collecting income tax and other domestic direct taxes. This explanation – termed the Administrative
Capabilities Hypothesis (ACH) in current research – posits that the costs of collecting income taxes are high in
developing countries, leading bureaucracies to collect more revenue from tariffs. Developing countries tend to
have archaic tax administrations which are unable to competently assess tax liabilities and monitor domestic
compliance to tax laws effectively (Khattry and Rao, 2002). Structural characteristics of taxpayers in developing
countries further weaken the bureaucracy’s ability to raise revenue through direct taxes. Firstly, given that
literacy is required for citizens to file income taxes (Riezman and Slemrod, 1987), low levels of education
amongst citizens of developing countries hamper the government’s efficacy in collecting income taxes. Kenny
and Winer (2006) showed that educational attainment and school enrolment were positively related to individual
income tax revenue share and negatively associated with trade tax rates. Secondly, income tax compliance
monitoring and collection is hindered when the rural taxable population is geographically dispersed. Meanwhile,
tariffs are less costly to collect because taxable trade activity tends to be centralised in a few ports (Aizenman,
1987; Gardner and Kimbrough, 1992).
Yet, the ACH fails to consider the costliness of tariff collection due to complex tariff codes (Adam, 2009).
Empirical evidence for it has also been mixed. In Mahdavi (2008)’s study of tax revenue mix in developing
countries, the association between urbanisation and trade tax revenue share of GDP was insignificant.
Additionally, while Kenny and Winer (2006) found a negative association between educational levels and trade
tax rates, the association of the former with trade tax revenue share was insignificant.
2.2 Explaining tariff revenue dependence using political economy
Alternative explanations for tariff revenue dependence built on political economy theories have also emerged.
Kenny and Winer (2006) and Mahdavi (2008) proposed that in countries with authoritarian institutions
(regardless of the country’s level of economic development), the regime lacks legitimacy in the eyes of the
citizenry. This makes it harder for the government to enforce direct taxation, pushing it to collect more revenue
from indirect taxes instead. However, this “democratic legitimacy” explanation is unable to account for the
insignificant relationship between democracy and trade tax share found in both studies, particularly when the
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sample is not restricted to developing countries as was the case for Kenny and Winer (2006). Adam (2009)
suggested an alternative political explanation by focusing on voters’ interests and using a theoretical model
developed by Moutos (2001). He showed that in an environment where a vertically-differentiated good is traded,
with developing countries exporting low-quality versions to the rest of the world and importing high-quality
ones (Schott, 2004), tariff revenues encompass greater proportions of developing countries’ government
revenues as they become more democratic. Democratisation expands the selectorate to shift decisive trade and
tax policy positions away from the rich elite to the poor median voter who consumes low-quality, locally-
produced goods (Fajgelbaum et al., 2011; Bils and Klenow, 2000). The prices of low-quality, domestically-
produced goods are not affected by tariffs, so the median voter consuming low-quality goods will be
‘impervious to the imposition of tariffs’ but not higher income taxes (Adam, 2009, p. 611). Adam thus predicted
that majority voting will result in higher tariff revenue shares. Using a sample of 64 countries labelled by the
World Bank as Low Income, Lower-Middle Income or Upper-Middle Income, which fitted his assumptions of
trade patterns, Adam found that democracy had the expected positive sign and remained significant even after
controlling for bureaucratic quality, while not all ACH variables were significant.
2.3 What role can electoral institutions play?
However, Adam’s theory does not consider that democracies vary in form, particularly in terms of electoral
district magnitude. His theory presupposes a majoritarian system of democracy and is highly dependent on the
median voter to explain outcomes. Yet, according to the Database of Political Institutions (DPI) (Beck et al.,
2001), approximately 50% of countries classified as Low, Lower-Middle and Upper-Middle Income have some
form of proportional representation (PR) electoral system. When district magnitude exceeds 1, the median voter
may not be solely decisive, resulting in different conclusions regarding equilibrium tariff revenue share. No
study to date has investigated whether this is the case.
Much of existing research on the effect of electoral institutions on trade policy has uncovered a “protectionist
bias” in majoritarian systems: the majority party maximises the joint welfare of a majority of but not all districts,
and therefore adopts higher tariffs to redistribute income to industries linked to districts controlled by the
majority party (Grossman and Helpman, 2005). In contrast, in a PR system, the legislature is more insulated
from regional protectionist pressures (Rogowski, 1987), or more likely to represent the interests of the country
as a whole (Evans, 2009). Such theories focus on producers’ trade preferences, usually expressed through
narrow interest groups, instead of the preferences of ordinary voting consumers. An extension of Adam (2009)’s
4 THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE
research might complement the majoritarian bias literature by providing an alternative, consumer-centric
perspective on how electoral institutions influence trade policy.
The broader literature on the representational consequences of electoral systems might similarly suggest that PR
systems exhibit lower tariff revenue shares. In developing countries, wealthy voters who demand high-quality
imports are the minority, and PR systems might lend these pro-trade minority interests greater influence over
policymaking. It has been argued that electoral systems with higher district magnitudes produce more
proportional electoral results (Taagepera and Shugart, 1989; Cox, 1997) that enhance political representation of
minority groups by lowering the vote share threshold required by a party to guarantee a legislative seat. Cross-
national and country-level studies of electoral district magnitudes in socially heterogeneous countries provide
evidence of a positive association between district magnitude and minority representation (Ordeshook and
Shvetsova, 1994; Clark, Gilligan and Golder, 2006). Since rich elites who import high-quality goods form the
minority of the electorate in developing countries, we might expect that higher district magnitudes enhance the
electoral representation of interests favouring imports and lower tariffs in developing countries, resulting in
lower tariff revenue shares.
2.4 Inequality, tariffs and voter preferences
Political economy explanations for tariff revenue dependence imply that tariffs serve a redistributive function
alongside other taxes: due to income-based differences in patterns of consumption and tendencies to import
high-quality goods, poor voters desire that the government raise more revenue via tariffs than income taxes so
that the tax burden is shifted from the poor to rich importing voters (Moutos, 2001; Adam, 2009). It has been
suggested that a rise in income inequality in a democracy – defined as an increase in mean income relative to
median income – increases voter demand for redistribution by taxation (Meltzer and Richard, 1981). Hence we
might expect inequality to influence how an electoral system aggregates voter preferences over tariff revenues in
a developing country.
To date, we know that inequality affects tariff revenue share directly, but the interaction between inequality and
electoral systems in determining tariff revenue share has yet to be investigated. Katsimi and Moutos (2010)
suggested that in a developing country engaging in vertically-differentiated trade, inequality is nonlinearly
related to tariff revenue share. In their model, higher inequality increases demand for redistribution through both
income taxes and tariffs. However, the optimal weight placed on each tax instrument depends on the existing
level of inequality. This is because the level of inequality determines the size of the tariff tax base and the extent
THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE 5
to which it shrinks in response to higher tariffs (assuming changes in inequality are mean-preserving), which in
turn affects the revenue that can be collected from tariffs. Dutt and Mitra (2002) obtained similar findings in the
context of horizontally-differentiated trade: they found that the relationship between inequality and
protectionism depends on a country’s present capital endowment. These studies suggest that mean-preserving
increases in income inequality change the relative intensities of pro- and anti-tariff preferences among voters,
and may therefore influence the aggregation of policy preferences over tariffs.
In light of the findings and shortcomings of existing literature, I develop a theory that explains the effect of
varying electoral district magnitude on the aggregation of tariff preferences and the eventual tariff revenue share
allocated by the government.
3. Theory and Hypotheses
3.1 Setup
I propose a theory which extends Adam’s (2009) framework, explaining how tariff preferences are aggregated
under electoral systems of varying district magnitude. To do so, I first make the same assumptions regarding
world trade and consumer preferences as Adam did.
I assume that world trade operates such that specialisation of production takes place within a product type and
across quality levels of a vertically-differentiated good. Schott (2004) found that factor endowments can explain
within-product specialisation but not across-product specialisation in trade between the United States and
various developing and developed country trading partners. Capital-abundant, developed countries use their
endowment advantage to produce and export high-quality good varieties, while developing countries conversely
export low-quality goods and import high-quality ones from the developed world.
I also use the model developed by Moutos (2001) to define individuals’ preferences regarding tariff revenue
dependence in a developing country based on income and consumption patterns. Consider a vertically-
differentiated good � with quality �. Each consumer purchases 1 unit of � or none of it, but can choose quality
� from a range of continuous values to maximise utility. There is a “dividing” level of quality ��, below which
the developing country produces � at lower marginal cost than developed countries. Since the consumer would
like to minimise the price he/she pays for the good and price varies positively with marginal cost, the consumer
purchases quality levels below �� domestically at the price of the locally-produced good ����� , and imports
quality above �� from developed countries at price ��� under free trade. The consumer thus faces the
following budget constraint:
6 THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE
� = ���� + ������if� < ����� + ����if� ≥ ��� (1)
where � is pre-tax income, � is the number of units of a homogeneous good consumed and � is the quality of a
fixed unit of the vertically-differentiated good consumed. The consumer maximises utility �(�, �) subject to
this budget constraint. Low-income consumers are assumed to maximise utility by consuming � < �� , while
high-income consumers maximise utility by consuming � > ��1.
The government has 2 tax instruments at its disposal – tariffs and income taxes – and raises revenue either by
implementing only tariffs (tariff revenue share 100%) or only income taxes (tariff revenue share 0%). With
income tax of rate 0 ≤ � ≤ 1 the budget constraint becomes:
�(1 − �) = ���� + ������if� < ����� + ����if� ≥ ��� (2)
and with a flat tariff " > 0 the budget constraint becomes:
� = � ��� + ������#$� < ��′��� + (��� + ")�if� ≥ ��′� (3)
where �� ′ is the new dividing quality, and ��& > �� since high-quality imports have become more expensive.
Figure 1 illustrates these new budget constraints and the corresponding new in utility-maximising (�, �) bundles for low-income consumers in a developing country. It shows that low-income consumers have higher
utility when government revenue is collected from tariffs rather than income tax. Low-income consumers spend
a larger share of their incomes on low-quality, locally-produced goods instead of high-quality imports, and are
therefore less sensitive to tariff hikes. High-income consumers, however, are more likely so spend a larger
share of their incomes on high-quality imported goods where � > ��, and thus obtain higher utility when
government revenue is collected from income tax rather than tariffs, making them more sensitive to tariff hikes.
[Figure 1 here]
3.2 Tariff preference aggregation under different district magnitudes
Based on these assumptions and the context of a developing country, I first consider the outcomes of political
competition in terms of tariff revenue share when district magnitude equals 1. My reasoning is guided by
Hotelling (1929)’s framework of competition as applied to party competition by Osborne (1995). There are ' citizens, and each citizen # has a complete and transitive preference relation over tariff rates such that each
citizen has a unimodal, symmetric distribution of utility over tariff rates, and gains highest utility from a most
preferred tariff rate ()* . Assume that citizens vote sincerely for candidates contesting a district based on tariff rate
THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE 7
preferences, which vary with income as described in Section 3.1. There is a one-dimensional policy space ,
identified by a real line, which contains a unimodal distribution of voters’ ideal tariff rates. By restricting our
analysis to the single dimension of tariffs, we assume that preferences over other taxes are implicitly determined
by preferences for a particular tariff rate; for instance, a voter that has a high ideal tariff rate will have a low
ideal income tax rate, since tariffs and income taxes are substitute sources of government revenue.
As for the election candidates, there are - of them, each with a different party affiliation for simplicity and a
preference relation over ,. When a candidate . takes the policy position (/, his/her vote share is 0/((/). Candidate .’s preferences over , are then structured such that he/she gains highest utility from a position that
yields him/her the highest vote share amongst all candidates (. wins by plurality), followed by a position that
yields him/her a vote share equal to another candidate with the next highest vote share (. ties), followed by a
position that does not give him plurality (. loses).
The game of district-level electoral competition is as follows. It is a simultaneous one-shot game in which there
are 2 players2, candidates . and 1, who choose tariff rate platforms (/ and (2 respectively from the distribution
of voters’ ideal tariff rates. Candidates earn payoffs in terms of vote shares 0/3(/4 and 02((2). It can be shown
that the outcome of this game is a unique Nash equilibrium where candidates . and 1 both adopt the median
voter ideal tariff rate 5 and tie in vote shares (see Online Appendix A). In a developing country, the proportion
of society that is poor outweighs the proportion of the rich. Hence, the median voter is poor, and as explained
earlier, has a greater propensity to consume low-quality goods. Low-quality goods are produced domestically in
a developing country and their prices are not affected by tariffs. Assuming citizens vote based on economic
preferences, the median voter is less sensitive to tariffs than his/her richer counterpart, and is more supportive of
the government raising tariffs than other taxes such as income tax. Therefore, when district magnitude is 1, the
elected legislator in each district represents the poor median voter’s tariff preferences, and will vote to increase
tariff revenue share in the legislature. Replicating this result across all single-member electoral districts in the
country, most if not all politicians with a seat in the legislature favour increased tariff collection, and the
legislature votes to collect a high proportion of government revenue from tariffs.
I now consider political competition over tariff policy positions when district magnitude exceeds 1. In this case,
several features of the aforementioned game are modified. Firstly, the number of electoral contenders in a
district is likely to increase beyond 2 candidates3. When there are more than 2 candidates, it can be shown that
there is no pure strategy Nash equilibrium where all candidates converge to the same position, at the median or
8 THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE
elsewhere, even if each aimed to win a plurality of votes to guarantee winning a seat (see Online Appendix B).
Therefore, candidates may not pander to the poor median voter’s preferred tariff policy in their campaigns.
Some candidates may choose to represent the rich minority’s preference for lower tariffs, while other candidates
may continue to represent poor voters. This increases the likelihood of candidates contesting elections on
platforms advocating lower tariffs.
Secondly, on top of being more likely to contest elections, candidates representing the rich minority are also
more likely to guarantee a legislative seat in a multimember district under PR arrangements when they contest.
When more than 1 legislator can be elected in a district, the minimum vote share needed by any candidate to
guarantee a seat, or the exclusion threshold, decreases. To illustrate, consider a list PR system that allocates
seats in a multimember district using quotas. A quota 6 is the minimum number of votes that guarantees a
candidate a seat in a district ":
6 = 7�8� + 9 (4)
where 7� is the total number of valid votes cast in district ", 8� is the number of seats contested in district "
(i.e. district magnitude), and 9 is a modifier that varies in value with the type of quota used (Clark et al., 2009).
The exclusion threshold : is then given by the ratio of the quota to the total number of votes cast4:
: = 67� =
18� + 9 (5)
Equation (5) implies that : decreases as 8� increases. Hence, as district magnitude increases, the threshold for
guaranteed representation falls towards the vote share obtained by candidates representing wealthy minority
interests, and candidates advocating tariff rates lower than the median voter’s ideal rate are more likely to be
elected to the legislature. Overall, under large district magnitudes, wealthy pro-trade interests gain political
representation and moderate the poor majority’s preferences for high reliance on tariffs revenues. Hence, I
expect to see lower tariff revenue shares when district magnitudes are greater than 1, and I test the following:
Hypothesis 1: In comparing developing countries with democratic elections, higher electoral district
magnitude is associated with lower tariff revenue share of government revenue.
Note that Hypothesis 1 reflects a “majoritarian bias” similar to that found by Grossman and Helpman (2005).
Therefore, my hypothesis may provide an alternative explanation for the “majoritarian bias”, one that considers
the role of consumer preferences in influencing protectionist policies.
3.3 The effect of inequality on tariff preference aggregation under different district magnitudes
THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE 9
A second hypothesis concerns the effect of income inequality on the aforementioned institutional explanation
for tariff revenue dependence. Extending Katsimi and Moutos’ (2010) reasoning, I propose that a mean-
preserving increase in inequality causes the number of voters who can afford high-quality imports to fall relative
to voters who cannot afford high-quality imports. As a result, the proportion of voters with high incomes that
would vote for lower tariffs and tariff revenue share falls. This reduces the probability that a candidate
representing wealthy pro-trade minority interests wins a seat. Using threshold : defined in Section 3.2, suppose
that the probability that candidate . wins a seat in an 8-seat district " with - contesting candidates is �;<=>: �;<=> = � 1if0/ ≥ :
ℎ30/ , -,8�4if0/ < :� (6)
where 0/ is .’s vote share, and ℎ&(0) > 0, ℎ&(8�) > 0 (i.e. �;<=> increases with own vote share and district
magnitude respectively). Section 3.2 showed that increasing 8� to 8�′ reduces the exclusion threshold to, say,
:’ < :. The expression for �;<=> becomes:
�;<=> = � 1if0/ ≥ :′ℎ30/ , -,8�′4if0/ < :′� (7)
where ℎ30/ , -,8�4 < ℎ30/ , -,8�′4; that is, holding all else constant, the probability that . wins a seat increases
as district magnitude increases, as shown in Section 3.2.
Now consider the effect of a mean-preserving increase in income inequality on �;<=> . If . were a candidate
representing wealthy pro-trade minority interests, increased inequality lowers his vote share to 0/′, and �;<=> falls since ℎ&(0) > 0. Figure 2 illustrates how �;<=> falls with increased inequality. If inequality is severe, �;<=> could even fall below the probability of winning under a lower district magnitude. Consequently, high inequality
reduces the efficacy of large district magnitudes in increasing the political influence of minority interests
through the electoral mechanism. The extent to which large district magnitudes lower the equilibrium tariff
revenue share is thus diminished with high inequality.
[Figure 2 here]
This leads me to test:
Hypothesis 2: In comparing developing countries with democratic elections, an increase in district
magnitude should lower tariff revenue share of government revenue by less when inequality is high.
4. Methodology and Data
4.1 Model
10 THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE
I empirically test the aforementioned hypotheses using the following fixed effects regression model:
A-_:CD'EE*> = FG8H8�*> + FIJ'-'*> + FKJ'-'I*> + FL8H8�*> ∗ J'-'*> + NOPQ--QRR*> + ST*> +UV*> + WX*> + YZ*> + [* + \*> where i indexes the country and t the year. LN_TARIFF measures natural log of tariff revenue share, MDMH
measures district magnitude, the main treatment for Hypothesis 1, and MDMH*GINI measures the interaction
between the Gini inequality index and district magnitude to test Hypothesis 2. Data used to construct these
variables are described in Section 4.2.1. OPENNESS measures trade share of GDP (see Section 4.2.3). C is a
vector of controls for MDMH. A is a vector of variables for ACH explanations. E is a vector of variables for
elite dominance explanations. N is a vector of variables for nontax revenue sources as alternative explanations.
[* denotes country fixed effects. Standard errors are clustered by country.
4.2 Data
The overall dataset describes 139 developing countries between the years 1990 and 2013. The dataset is
restricted to 139 countries as I only use countries classified by the World Bank as Low Income, Lower-Middle
Income or Upper-Middle Income to satisfy the assumption that developing countries export low-quality
products. Only the period between 1990 and 2013 is covered by this study due to data availability.
4.2.1 Treatment and outcome variables
The outcome variable is LN_TARIFF, which describes the log of customs and import duties as a share of tax
revenue from the World Development Indicators (WDI). The treatment testing Hypothesis 1 is district
magnitude, captured by the variable MDMH. MDMH describes mean district magnitude in the lower house from
the DPI. Only lower house data is used because not all countries in the sample have multi-chamber legislatures.
Country-years where district magnitude is coded as Not Applicable or Indirect are excluded5. The treatment
testing Hypothesis 2 is income inequality, as captured by the variables GINI, its square GINI2 and the interaction
MDMH*GINI. These variables are constructed based on Gini indices from the WDI. While Gini indices are
reported only for 740 out of 7367 country-year observations in the dataset, its strength lies in its common usage
by many researchers, which facilitates comparison across studies.
4.2.2 Control variables (C)
As controls, I include variables that potentially cause the non-random assignment of district magnitudes to
national economies and confound the relationship between political institutions and trade and tax policy
outcomes. The first set of controls comprises dummy variables that indicate whether a country has based its
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legal system on English, French, German, Socialist or Scandinavian law: LEGOR_UK, LEGOR_FR,
LEGOR_GE, LEGOR_SO and LEGOR_SC respectively (La Porta et al., 1999). The second set of controls
comprises dummies for structural adjustment agreements that potentially affect variations in both political
institutions and trade and tax policies: IMF_SBA and IMF_EFF indicate whether a country signed an IMF
Stand-By Agreement or Extended Fund Facility agreement respectively in a year (Dreher, 2006). Finally, the
level of economic development as measured by real per capita income from the WDI, and captured by the
variable INCOME, is controlled for.
4.2.3 Alternative explanations: Tariff tax base
A country may be highly dependent on tariff revenues simply because its taxable tariff base is large. I use the
variable OPENNESS, which measures total trade (exports plus imports) share of GDP from the WDI, to proxy
the size of its tariff base in a given year.
4.2.4 Alternative explanations: Nontax revenue sources (N)
A government can rely less on tax revenues if it obtains funds from other sources. To account for these
alternative revenue sources, I firstly include variables OIL and MINERAL, which measure oil and mineral rents
respectively as a percentage of GDP. I also include the variable ODA, which measures the amount of net official
development assistance received as a share of GDP, as well as IBRD, which measures loans from the
International Bank for Reconstruction and Development and credits from the International Development
Assistance as a share of GDP. Data was obtained from the WDI.
4.2.5 Alternative explanations: Administrative Capabilities Hypothesis (A)
As suggested by the ACH literature in Section 2.1, numerous factors affect the government’s administrative
capabilities of collecting directing taxes and the extent it might have to rely on indirect taxes like tariffs as a
substitute. I therefore include BUREAUQUAL as a measure of bureaucratic quality according to the
International Country Risk Guide (ICRG), measures of population size POP and population density POPDEN,
rural population share as a measure of urbanisation and secondary school enrolment rates SECONDARY to
measure the population’s education level. I also include the ICRG corruption index CORRUPT since corruption
also negatively affects the government’s ability to collect various taxes (Bai and Wei, 2001; Gatti, 1999).
4.2.6 Alternative explanations: Elite dominance (E)
My proposed theory requires that legislatures are ‘mature and autonomous’, capable of ‘injecting the interests
and concerns of their constituencies into the policy process’ (Diamond, 1997). Yet, numerous developing
12 THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE
country democracies suffer from weak legislatures that face obstacles in representing voters’ interests. This
potentially renders voter preference aggregation mechanisms irrelevant in determining tariff revenue share.
To begin, financial crises may provide opportunities for wealthy elites with pro-trade views to exercise
influence over policymaking, as was the case in Latin America during the 1990s. To estimate the effect of this
phenomenon, I include a variable BANKCRIS, which codes the occurrence of a banking crisis in a particular
country-year, as a proxy for instances of economic distress. Data was obtained from Caprio et al. (2003) and
Laeven and Valencia (2008).
Dominant parties in developing countries may also mediate the influence of the poor majority through the
legislature by over-representing elites’ policy positions. Dominant parties are distinguished from majority
parties in democracies by their use of state resources to reward supporters for their loyalty and prevent citizens
from holding elected legislators accountable to remain in power. They offer elites opportunities to influence the
policymaking process in exchange for their political support (Bogaards, 2004; Smith, 2005; Magaloni, 2006).
Given that elites possess large amounts of wealth, dominant parties reflecting wealthy elite interests are likely to
favour import-intensive consumption preferences and choose lower tariff revenue shares. To measure the
influence of dominant elite parties in developing countries, I use the variable GOV1RLC from the DPI, which
codes the orientation of the largest government party as Right (1), Centre (2) or Left (3). If GOV1RLC equals 1,
there exists a dominant elite party in the legislature in that developing country in that year. To validate that this
variable does capture elite dominance, I look at country-years in the sample that had a value of GOV1RLC equal
to 1, and refer to the Inter-Parliamentary Union’s Parliaments Online (IPU PARLINE) database to verify
economic policy positions of the largest party in each case. Where GOV1RLC was 1, the largest party tended to
have views supporting of trade liberalisation (see Online Appendix C). However, GOV1RLC also risks being
endogenous to district magnitude. Hence I run alternative models using PARCOMP, an index of the
competitiveness of political participation from the Polity IV database (Marshall et al., 2013), to proxy the
potential for elite dominance in a developing country democracy. In developing countries, wealthy elites will
always be the minority even under the most proportional form of electoral representation, thus they should not
be expected to competitively gain dominance. Being coded based on constitutional features, PARCOMP is
exogenous to district magnitude.
A chief executive with a strong mandate could also render the influence that voters have through the legislature
less relevant to policymaking. To measure the degree of executive dominance, I use the variable XCONST from
the Polity IV dataset, which measures the degree of institutionalised horizontal constraints on the decision-
THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE 13
making powers of chief executives. The variable is coded from 1 to 7, with 7 indicating the highest degree of
limitations imposed by the legislature and other veto players. Executive influence may also weaken the
legislative mandate if the executive controls legislative decisions through a majority party in the legislature that
he/she is aligned with. I code such a scenario using the variable ALLHOUSE from the DPI, a dummy indicating
whether the executive’s party has an absolute majority in the houses that have law-making powers. Since both
XCONST and ALLHOUSE pertain to constitutional characteristics, they are exogenous and do not pose bad
control problems. However, they do not adequately capture the policy positions of strong executives. I therefore
run alternative specifications using the right-left orientation of the chief executive EXECRLC from the DPI as a
measure of elite dominance in place of XCONST and ALLHOUSE. EXECRLC takes on 3 possible values: Right
(1), Centre (2) or Left (3). Overrepresentation, and therefore dominance, of economic elites leads to a higher
probability of right-wing chief executives taking office (Albertus and Menaldo, 2013). Such executives, then,
are free to influence policymaking to reflect policy interests of the wealthy should they face few horizontal
constraints. EXECRLC is useful in distinguishing between cases where chief executives led the implementation
of pro-trade policies in line with wealthy interests in our model, and where they opposed such liberalisation (see
Online Appendix D). It is, however, a bad control like GOV1RLC.
5. Results and Analysis
5.1 Initial empirical results
Table 1 presents the results of the fixed effects panel regressions. As within-estimators are used, the regressions
drop legal origins, which are time-invariant controls; their effects are instead captured by country fixed effects.
Models 1 and 2 show uncontrolled regressions of tariff revenue share on district magnitude, the Gini coefficient,
and their interaction. In both models, the coefficients on MDMH are negative and significant at the 1% level. A
1 unit increase in district magnitude reduces tariff revenue share by approximately 0.0079 log points. This
supports the prediction of Hypothesis 1. The coefficients on MDMH*GINI are positive and significant in both
models as well. To interpret this coefficient, consider how it changes estimated coefficient on MDMH when
GINI increases by 1 unit; that is, the marginal effect of MDMH on LN_TARIFF. The marginal effect is given by:
Marginal effect of MDMH = (coefficient on MDMH) + (coefficient on MDMH*GINI)*GINI
= FG + FL ∗ J'-' Table 1 shows that the estimated FG is negative and that FL is positive. This means that as GINI increases by 1
unit, the marginal effect becomes less negative by FL units. Since FL is statistically significant, there is
14 THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE
significant evidence that increased inequality moderates the negative effect of higher district magnitudes on
tariff revenue share. This supports Hypothesis 2, which predicts that higher inequality enhances the influence of
poor interests for higher tariff revenues even under more proportional electoral systems. Model 2 also includes
the quadratic term GINI2; this reduces standard errors on the coefficients of MDMH and MDMH*GINI.
Model 3 sees the addition of controls, and Models 4 through 7 the addition of alternative explanations. The
coefficients on MDMH and MDMH*GINI remain at the 5% level in all models. In Model 7, which includes all
alternative explanations and controls, a 1 unit increase in district magnitude is associated with a 0.01 log-point
reduction in tariff revenue share. Every 1 Gini unit increase in inequality then reduces the magnitude of this
decrease in tariff revenue share by 0.00034 log-points.
[Table 1 here]
[Figure 3 here]
The effect of inequality on the relationship between district magnitude and tariff revenue share is further
illustrated in Figure 3. As GINI increases, the marginal effect of MDMH on LN_TARIFF becomes less negative.
Beyond GINI value of approximately 29.5, an increase in district magnitude increases tariff revenue share as the
coefficient of MDMH becomes positive. This positive coefficient becomes significant at the 5% level beyond
GINI index of approximately 33. This is the minimum level of income inequality at which the influence of a
poor majority overcomes the effect of having proportional electoral representation of economic elites.
5.2 Relationship with existing research: Administrative Capabilities Hypothesis
My results suggest that the political explanation considering district magnitude may be complementary to ACH
explanations offered by existing research. The addition of ACH variables in Model 6 in does little to change the
coefficients and standard errors on MDMH and MDMH*GINI. Additionally, the introduction of ACH variables
produces a relatively large increase in R2 from Model 5 to 6, implying that district magnitude explains a
statistically orthogonal dimension of variation in LN_TARIFF compared to bureaucratic quality and does not
overlap with ACH in explanatory power.
5.3 Relationship with existing research: Producer-centric “majoritarian bias” literature
[Table 2 here]
The traditional “majoritarian bias” literature places great emphasis on the way different electoral systems
aggregate producer preferences over trade protection. For this reason, scholars subscribing to this view need not
consider consumer characteristics, such as spending power and inequality thereof, when carrying out research.
THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE 15
In contrast, I focus on explaining how different electoral systems aggregate consumer preferences over trade tax
instruments; therefore I account for variations in consumer characteristics, specifically income inequality. To
compare the efficacy of consumer-centric explanations against producer-centric ones in explaining tariff
revenue dependence, I compare Model 7 to other regression models which have omitted direct inequality effects
(Model 10), interactive inequality effects (Model 9), or both (Model 8), ceteris paribus. The results in Table 2
show that the coefficient on MDMH is negative and significant only when the interactive effect of district
magnitude and inequality is included. This suggests that the electoral system cannot, by itself, explain variations
in the government’s dependence on trade tax as a revenue source; rather, electoral systems can only account for
trade tax revenues when income inequality is considered. If producer preferences were primarily driving trade
tax revenues, district magnitude should by itself significantly account for variations in trade tax shares, without
interaction with inequality (for instance see Evans, 2009). Yet, an interaction with inequality is required for
significant results. Since the concept of income inequality is industry-blind and linked to consumer rather than
producer preferences, Table 2 suggests that explaining trade tax revenue variations using electoral systems
requires that consumer preferences, rather than sector-specific producer preferences, are also taken into account.
5.4 Robustness checks
5.4.1 Alternative measures of elite dominance
As explained in Section 4.2.6, problems belie the use of GOV1RLC as a measure of elite party dominance, and
XCONST and ALLHOUSE as measures of elite-allied executive dominance. I therefore test whether the earlier
conclusions remain robust when different measures of elite dominance are used. The results are shown in Table
3: I find that the conclusions regarding the directions of postulated relationships remain unchanged.
[Table 3 here]
Model 11 uses competitiveness of political participation, PARCOMP, to measure the likelihood of single parties
with elite support dominating legislatures. Using PARCOMP in place of GOV1RLC hardly changes the
coefficients on MDMH and MDMH*GINI as well as their standard errors. In Model 12, GOV1RLC is retained
while XCONST and ALLHOUSE are replaced with the left-right orientation of the executive, EXECRLC.
Consequently, the coefficient on MDMH becomes less negative but remains significant. The coefficient on
MDMH*GINI, on the other hand, retains its hypothesised sign but becomes insignificant. Similar results apply
to Model 13, which modifies Model 12 by also replacing GOV1RLC with PARCOMP. It therefore appears that
the effect of district magnitude is robust to alternative specifications of elite dominance, but the same cannot
always be said for the interactive effects of district magnitude and inequality.
16 THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE
5.4.2 Alternative inequality metrics
A shortcoming identified with using the WDI Gini index as a measure of income inequality is the paucity of
observed data points. This limits the size of the sample used for the regression, potentially reducing population
representativeness as well as the precision of estimates. As a check on initial results, therefore, I repeat the
regression using an alternative inequality metric – multiple imputation estimates of inequality measures from the
Standardised World Income Inequality Database (SWIID) (Solt, 2009). Since estimates are provided for
country-years where the WDI Gini index is unavailable, this dataset is more complete and expands the sample
size for regression analysis. Table 4 shows the results of regressions run using SWIID data; these results show
that even with alternative inequality metrics, the coefficients on MDMH and the interaction between district
magnitude and inequality retain the hypothesised signs and statistical significance.
5.4.3 Year fixed effects
Events in particular years may systematically affect governments’ dependence on protectionism and tariffs
across the developing world. To rule out the possibility that district magnitude is simply capturing this effect, I
run regressions which include year fixed effects as shown in Table 5. In Model 16, dummies for all years
covered in the dataset are included, while in Model 17, I only include a dummy COLDWAR for the year 1990,
the approximate year by which the Cold War is understood to have ended. The end of the Cold War marked the
triumph of neoliberalism and could have weakened protectionist tendencies, reducing tariff revenue dependence
systematically across the developing world. I find that in both models, coefficients on MDMH and
MDMH*GINI all retain their hypothesised signs and significance.
6. Conclusion
In this paper, I extend existing research on political factors driving developing countries’ dependence on tariff
revenues by exploring the impact of varying electoral district magnitude across democracies on tariff revenue
share in developing countries. While existing literature has found that democracy increases tariff revenue shares
by aggregating the preferences of the poor majority of voters over tax structures and trade policy, I propose that
it is not just the level of democracy but also its form that matters. Against a backdrop of developing countries
participating in vertically-differentiated trade and residents with consumption-based trade preferences, I
hypothesise that larger district magnitudes result in lower tariff revenue shares as they allocate wealthy, anti-
tariff economic elites greater influence over policy, whilst softening the influence of the poor median voter who
is less affected by higher tariffs than rises in other voluntary direct taxes. I also propose that as income
inequality rises, tariff revenue shares increase even under large district magnitudes. Using panel data fixed
THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE 17
effects linear regression, I find empirical evidence supporting both propositions: lower house district magnitude
is negatively associated with tariff revenue share of government revenue, and this association becomes less
negative at higher levels of inequality. These results are robust even after accounting for alternative factors.
Certainly, further research can build on these results to enhance our understanding of political factors behind
trade policy and tax structures. Future studies may consider the impact of voter turnout on the results found
here. I have assumed full turnout, but in reality the poor may be less likely to vote, resulting in the electorate’s
aggregated preferences reflecting those of voters wealthier than the average citizen (Larcinese, 2007).
Additionally, democracies vary along numerous other dimensions, and it may be worth studying whether other
institutions affect a developing country’s dependence on tariff revenues. Nevertheless, the findings of this paper
emphasise the importance of considering variations in forms of democracy when using political economy to
explain policy outcomes. It also provides additional insight to the challenges potentially faced by governments
in developing countries in balancing trade liberalisation with other economic policy goals, such as fiscal
sustenance.
18 THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE
Tables and Figures
Table 1: Within-estimates of determinants of tariff revenue share
(1) (2) (3) (4) (5) (6) (7)
Regressors Linear GINI Nonlinear
GINI
Incl.
controls
Incl.
openness
Incl.
nontax
revenues
Incl. ACH Incl. elite
dominance
MDMH -0.0079*** -0.0082*** -0.0057** -0.0059** -0.0056** -0.0047* -0.010***
(0.0011) (0.00083) (0.0024) (0.0023) (0.0021) (0.0023) (0.0024)
GINI -0.00050 -0.17*** -0.20*** -0.19*** -0.20*** -0.17*** -0.19***
(0.0093) (0.052) (0.055) (0.056) (0.054) (0.058) (0.058)
GINI2 0.0019*** 0.0022*** 0.0022*** 0.0021*** 0.0019*** 0.0020***
(0.00054) (0.00058) (0.00058) (0.00056) (0.00059) (0.00061)
MDMH*GINI 0.00025*** 0.00025*** 0.00018** 0.00017** 0.00017** 0.00014* 0.00034***
(0.000045) (0.000032) (0.000072) (0.000067) (0.000072) (0.000080) (0.000082)
IMF_SBA -0.091 -0.11 -0.092 -0.015 0.058
(0.11) (0.11) (0.14) (0.10) (0.090)
IMF_EFF 0.011 -0.059 -0.12* -0.17* -0.26
(0.086) (0.095) (0.062) (0.082) (0.17)
INCOME -0.00010 -0.000075 -0.00013 -0.00012 -0.00014*
(0.00011) (0.00011) (0.00011) (0.000082) (0.000083)
OPENNESS -0.010* -0.0050 0.0050 0.0054
(0.0058) (0.0060) (0.0036) (0.0037)
OIL 0.0020 0.014 0.031
(0.019) (0.018) (0.021)
MINERAL -0.033 -0.048** -0.063***
(0.027) (0.021) (0.015)
IBRD -0.53 0.24 -1.39
(2.77) (1.98) (1.87)
ODA 0.025 -1.07 0.47
(1.61) (2.71) (2.18)
BUREAUQUAL -0.18 -0.21
(0.15) (0.16)
POP 7.4e-11 2.6e-09
(2.5e-09) (3.2e-09)
RURAL 0.023 0.031
(0.036) (0.030)
POPDEN 0.00034 -0.0034
(0.0072) (0.0091)
SECONDARY -0.0046 -0.012
(0.012) (0.0084)
CORRUPT 0.18*** 0.20***
(0.058) (0.055)
XCONST 0.045
(0.053)
ALLHOUSE -0.53**
(0.20)
GOV1RLC 0.049
(0.052)
Constant 2.15*** 5.75*** 6.82*** 7.37*** 7.71*** 5.31** 6.37**
(0.40) (1.23) (1.47) (1.49) (1.54) (2.38) (2.41)
Observations 322 322 319 319 196 140 124
R-squared 0.017 0.043 0.070 0.096 0.264 0.538 0.676
Number of id 77 77 75 75 39 31 30
Notes: Dependent variable is LN_TARIFF in all models. STATA dropped BANKCRIS because of multicollinearity.
Hausman test rejected random effects in favour of fixed effects. These regressions were also run with country fixed effects
entered as dummy variables, and F-tests rejected the joint null hypothesis that all country dummies have coefficient 0.
Clustered standard errors are shown in parentheses. *** p<0.01, ** p<0.05, * p<0.1.
THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE 19
Table 2: Comparing producer-centric and consumer-centric models
(7) (8) (9) (10)
Variables Unrestricted model MDMH only MDMH + direct
GINI effects only
MDMH +
interactive GINI
effects only
MDMH -0.010*** 0.00015 -0.00031 -0.0082***
(0.0024) (0.00038) (0.00061) (0.0026)
GINI -0.19*** -0.18***
(0.058) (0.058)
GINI2 0.0020*** 0.0021***
(0.00061) (0.00059)
MDMH*GINI 0.00034*** 0.00029***
(0.000082) (0.000088)
Constant 6.37** 3.87** 6.59** 2.25
(2.41) (1.76) (2.60) (1.95)
Observations 124 330 124 124
R-squared 0.676 0.423 0.620 0.623
Number of id 30 37 30 30
Notes: Dependent variable is LN_TARIFF in all models. Other variables for alternative explanations and controls are
included in all regressions here, but estimates of their coefficients are not shown for brevity. Clustered standard errors are
shown in parentheses. *** p<0.01, ** p<0.05, * p<0.1.
Table 3: Within-estimates using alternative measures of elite party and executive dominance
(7) (11) (12) (13)
Elite dominance
variables
XCONST,
ALLHOUSE,
GOV1RLC
XCONST,
ALLHOUSE,
PARCOMP
EXECRLC,
GOV1RLC
EXECRLC,
PARCOMP
MDMH -0.0100*** -0.010*** -0.0041** -0.0048*
(0.0027) (0.0026) (0.0019) (0.0025)
GINI -0.20*** -0.18*** -0.18*** -0.17***
(0.057) (0.062) (0.055) (0.058)
GINI2 0.0021*** 0.0018*** 0.0020*** 0.0019***
(0.00059) (0.00066) (0.00055) (0.00059)
MDMH*GINI 0.00034*** 0.00034*** 0.00010 0.00014
(0.000093) (0.000086) (0.000066) (0.000089)
XCONST 0.045 0.090
(0.053) (0.068)
ALLHOUSE -0.53** -0.51**
(0.20) (0.19)
PARCOMP -0.14 0.094
(0.15) (0.12)
EXECRLC -0.22*** -0.12**
(0.054) (0.053)
GOV1RLC 0.049 0.13**
(0.052) (0.060)
Constant 6.37** 6.24** 5.58** 4.83**
(2.41) (2.50) (2.27) (2.25)
Observations 124 124 140 139
R-squared 0.676 0.678 0.567 0.551
Number of id 30 30 31 31
Notes: Dependent variable is LN_TARIFF in all models. Other variables for alternative explanations and controls are
included in all regressions here, but estimates of their coefficients are not shown. Clustered standard errors are shown in
parentheses. *** p<0.01, ** p<0.05, * p<0.1.
20 THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE
Table 4: Within-estimates using SWIID inequality data
(7) (14) (15)
Inequality metric WDI Gini index GINI_EST: Estimated
Gini index of inequality
in household disposable
(post-tax, post-transfer)
income
SHARE1: Estimated share
of (pre-tax, pre-transfer)
income reported by top
1% of taxpayers
MDMH -0.010*** -0.00427* -0.00275**
(0.0024) (0.00222) (0.00112)
GINI_EST -0.19*** 0.00763
(0.058) (0.0643)
GINI_EST2 0.0020*** -0.000211
(0.00061) (0.000662)
MDMH*GINI_EST 0.00034*** 0.000167**
(0.000082) (7.30e-05)
SHARE1 -0.0409
(0.0407)
SHARE12 0.000751
(0.000716)
MDMH*SHARE1 0.000475***
(0.000166)
Constant 6.37** 2.227 2.125
(2.41) (2.570) (1.967)
Observations 124 286 286
R-squared 0.676
Number of id 30 33 33
Notes: Dependent variable is LN_TARIFF in all models. Other variables for alternative explanations and controls are
included in all regressions here, but estimates of their coefficients are not shown. For comparability, XCONST, ALLHOUSE
and GOV1RLC are used as elite dominance measures. Clustered standard errors are shown in parentheses. *** p<0.01, **
p<0.05, * p<0.1.
Table 5: Within-estimates with year fixed effects
(7) (16) (17)
Year effects None 1990-2013 1990
MDMH -0.010*** -0.012*** -0.0098***
(0.0024) (0.0039) (0.0022)
GINI -0.19*** -0.25*** -0.19***
(0.058) (0.056) (0.058)
GINI2 0.0020*** 0.0025*** 0.0020***
(0.00061) (0.00056) (0.00059)
MDMH*GINI 0.00034*** 0.00040*** 0.00033***
(0.000082) (0.00013) (0.000072)
COLDWAR -0.81*
(0.43)
Constant 6.37** 7.25** 5.55**
(2.41) (3.01) (2.66)
Observations 124 124 124
R-squared 0.676 0.809 0.690
Number of id 30 30 30
Notes: Dependent variable is LN_TARIFF in all models. Other variables for alternative explanations and controls are
included in all regressions here, but estimates of their coefficients are not shown. For comparability, XCONST, ALLHOUSE
and GOV1RLC are used as elite dominance measures. Clustered standard errors are shown in parentheses. *** p<0.01, **
p<0.05, * p<0.1.
THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE 21
Figure 1: Consumer utility with income tax or tariff collection
Figure 2: Pro-trade candidate’s probability of winning a seat in large district with lower vote share
Figure 3: Marginal effect of district magnitude on tariff revenue share
uL
0 = uL
2
uL
1
Qd Qd’ Q
H
B0
B1
B2
Low income
Qd Qd’ Q
H
uH
0 uH
1 uH
2
B0
B1
B2
Legend
B0: No taxes
B1: Income tax
B2: Tariffs
High income
Gini = 29.5
0.0
1.0
2.0
3.0
4
Ke
rne
l den
sity
est
ima
te o
f G
ini
-.0
05
0.0
05
.01
.015
.02
Marg
inal eff
ect
of
dis
tric
t m
agn
itude
on
ln(t
ariff
)
20 30 40 50 60 70
Gini coefficient (World Bank)Thick dashed lines give 95% confidence interval.Thin dashed line is a kernel density estimate of gini.
psea
pseat
vj’ T T’ T’
1
ℎ30/ , -,8�4 ℎ30/ , -,8�4 ℎ(8�) ℎ38�′4
22 THE POLITICAL ECONOMY OF TARIFF REVENUE DEPENDENCE
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Notes
1 Fajgelbaum et al. (2011) showed that the utility-maximising quality of a vertically-differentiated good
consumed increases with consumer income if quality levels are higher than average quality consumed by
individuals in the income group, and conversely decreases with income if quality is lower than average quality
consumed by individuals in income group; simply put, a low-income consumer to prefers a low-quality good if
the difference between high-quality and low-quality goods must be adequately substantial.
2According to Duverger's Law (1954), the mechanical and psychological effects produced by single-member
district plurality or majoritarian systems push the number of effective contesting parties to the minimal of 2 in a
democracy.
3Weaker Duvergerian mechanical and psychological effects due to more proportional seat allocation encourage
more small parties to contest elections.
4 Similar exclusion thresholds are also applicable to divisor systems of seat allocation, such as the d’Hondt
system (Lijphart and Gibberd, 1977; Taagepera, 1989).
5In doing so, I implicitly use a minimal procedural definition of democracy to restrict my sample, such that the
presence of elections (suggested by the existence of a legislature) indicates the presence of democracy. District
magnitude is only meaningful where there is at least procedural electoral democracy. I also tried restricting the
sample to developing countries that are at least “Partly Free” or “Free” according to Freedom House while
running the regressions in Section 5; doing so did not change my conclusions.