How War Funding Shapes States: Taxes Build Capacity, Loans Often Do Not

📌 Two Ways to Pay for War—and They Lead to Different States

Reexamines the connection between war and state-making by comparing two prominent modes of war finance: taxation and foreign borrowing. Financing war with taxes strengthens the state's ability to assess wealth and monitor compliance—core elements of fiscal capacity—and encourages the adoption of power-sharing institutions that make taxation a non-zero-sum bargain, extending war’s institutional effects into the long run. By contrast, financing war with external capital can fail to produce lasting fiscal capacity when borrowers interrupt debt service and default settlements result in war debt being condoned or swapped for nontax revenue.

🔎 Global Historical Evidence Since 1816

Presents empirical evidence drawn from wars around the world, with cases dating as early as 1816. The analysis compares episodes of tax-financed and loan-financed war to trace how wartime funding choices affect postwar fiscal institutions and political arrangements.

📈 Key Findings

• Tax-financed wars tend to increase the state’s practical ability to assess wealth and enforce tax compliance, helping to build long-term fiscal capacity.
• Tax financing also facilitates the emergence of power-sharing institutions that transform taxation into a non-zero-sum interaction, carrying the effects of war into political reform.
• Foreign loans do not reliably produce long-term fiscal capacity when wartime borrowers interrupt payments and default settlements lead to debt being condoned or exchanged for non-tax revenue.
• The globalization of capital markets in the nineteenth century weakened the historical association between war, state-building, and political reform by making external finance more available.

🧭 Why It Matters

Clarifies a mechanism linking war to state development: the mode of war finance matters. The findings imply that access to international capital can undercut the state-strengthening effects of wartime mobilization, with lasting consequences for fiscal institutions and political bargains after conflict.