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Paths Toward the Modern Fiscal State

0 Comments 🕔20.Nov 2014

The rise of the modern state is a topic that has not only interested political scientists, but sociologists and economic historians. A key element of this development is the evolution of public finance from being the private domain of the ruler to an extensive tax state. Wenkai He argues in his book that we cannot understand this aspect of state development without considering the interplay between tax revenue and the state’s use of credit. Defining the modern fiscal state as “…the centralized fiscal system that sustained the state’s creditwor- thiness in the financial markets” (p. 187), the puzzle that Paths Toward the Modern Fiscal State seeks to explain is why these features emerged in some countries but not in others. The answer is to be found in the impact of severe fiscal crises in conjunction with socio-economic factors.

The book adds to the growing literature in political science, economics, and sociology on the development of modern tax institutions. This literature has emphasized the extended extractive capacity of the state as one of the most important events in the development of the modern state. One of the more popular explanations for this development has been interstate warfare. Paths Towards the Modern Fiscal State provides an interesting new theoretical take on this crucial moment in state evolution and takes it to the data in the form of three historical case studies.

After an outline of the theory in the first chapter, the remainder of the book is ded- icated to a comparison of England in the seventeenth and eighteenth centuries (chapter 2) with Japan and China in the late nineteenth (chapters 3 through 6). The book describes how extraordinary fiscal crises in England and Japan fostered the birth of the modern fiscal state, while failing to do so in China.

The first part of the argument concerns the centralization of indirect taxation. In Wenkai He’s story, it all starts with a severe fiscal crisis that induces the state to consider new types of revenue. Which type of tax that is most efficient depends on socio-economic factors. For example, some taxes are aggressively opposed by important actors in society, while others are expensive or hard to collect. In England and Japan, excise taxation was the best available option, since land taxes were opposed by influential landed elites and were administratively burdensome. Moreover, economies of scale in ale and sake production had resulted in a few large manufacturers, which made it easier to administer a tax on alcohol. Since state debt was taken on centrally, an important development was the centralization of these indirect tax revenues. Collection and spending locally had existed before, but the emergence of the modern fiscal state requires the remittance of locally collected revenue to the center. This process was greatly helped by existing private banking networks, allowing safe and fast transfers of funds.

Once centralized, the revenue could be used to leverage long-term loans. This ability is intimately connected to the extractive capacity of the state, and the two variables are mutually reinforcing. In Wenkai He’s theory, there is no fixed causal direction between long- term finance and centralization of indirect taxation. In Japan, long-term liabilities in the form of paper notes emerged before centralization, and can be seen as causally prior. In England, there was a considerable time gap between centralization of excise and customs and the use of long-term debt. However, once both were in place, they strongly reinforced each other.

After the Second Anglo-Dutch war, the financial situation of the English state was acute, with a large build-up of short-term loans but dwindling tax receipts. The existing revenue from the royal domains was no longer sufficient to cover the expenses, and this endangered the ability to take on new debt. This led to the decision to centralize collection of taxes on trade, tobacco, and alcohol. In turn, it guaranteed a steady flow of income to the central state. While these reforms occurred already before the Glorious Revolution of 1688, it was not until the 1720s that long-term debt was institutionalized. This development was driven by costly external wars (such as the Nine Years War and the War of the Spanish Succession), which, in combination with a stable revenue stream from centrally collected taxes, made long-term debt a feasible source of funding. Specifically, the issuing of short-term loans backed by future tax revenues had to be abandoned in favor of fiduciary instruments in 1690. The high interest rate of these emergency measures led to the emergence of long-term, low-interest, domestic loans. The conversion of short-term liabilities into long-term debt was helped by domestic joint-stock companies – such as the East India Company – that could provide credit in exchange for a monopoly on trade. This method of transformation was much faster than using bank notes issued by the (at the time) underdeveloped Bank of England.

In contrast, Meiji Japan issued non-convertible paper notes for emergency war finance before the centralization of indirect taxes, laying the foundation for a subsequent credit crisis. After the abolishment of the domain system, the center took on locally issued debt, exacerbating the already grave debt situation, and forced Japan to take on foreign loans. Thus, the centralization of debt increased the need for centralized revenue collection. In order to continue the modernization of the armed forces and to legitimate the new regime, it was of crucial importance to maintain creditworthiness. Since tariffs were determined by western powers and raised land taxes were met with violent resistance, Japan was forced to rely on excise taxation. Centralization was facilitated by existing networks of private banks, a function that was later taken over by the Bank of Japan in 1883. Once centralized collection of excise taxes were in place, the use of long-term domestic bonds was a much easier step. Thus, the centralization of tax revenue in Japan was driven by the need to redeem the large amount of paper notes, and once in place it facilitated the use of long-term debt as a means of state finance.

The Taiping Rebellion is the starting point for the failed process toward a modern fiscal state in China. While the conflict created the necessary pressure for tax reform, it also destroyed the administrative capacity needed to transmit revenue from the provinces to Beijing. With the option of centralization prevented by the sheer severity of the conflict, but with a sustained need to pay the troops, the solution was continued, but improved decentralized collection. After the rebellion was put down, the domestic economy, as well as the private banking networks needed for transportation of revenue to the center, had recovered. Thus, the preconditions for a successful centralization existed. However, there were no severe fiscal crises acting as a pressure device for further centralization reforms. Wenkai He argues that, had such a crisis occurred in the decades after the rebellion, China might have developed a modern fiscal state similar to Japan and England.

In sum, in times of crisis, a state can move to the path toward the modern fiscal state given the right timing and socio-economic conditions.

While the argument about tax choice is clear, the same cannot be said of the reasoning about the role of warfare. On the one hand, it is an important cause of fiscal crises in all three case studies. On the other, Wenkai He claims it is neither a sufficient nor necessary condition. In the Japanese case, the need to modernize the army seems to be extremely present in policymakers’ calculations. Thus, even in its physical absence, external warfare was on top of the agenda in Japan. The very anticipation of conflict appears to have been enough. Otherwise, Japan could have solved many of its financial problems by reducing spending on its military. In the Chinese case, the Taiping Rebellion was so destructive that it hindered centralization. After the conflict ended, however, the subsequent wars (Xinjiang 1875–1884, Sino-French War 1883–1885) did not put enough pressure on the central government to induce reform. If China was able to fight large wars, repay foreign loans, and even handle the huge war indemnity to Japan after the Sino-Japanese war of 1894–1895, then one might question how inevitable the development in England and Japan really was.

In sum, it seems as if the role of warfare is to create just the right amount of crisis; not too much, but not too little. This might, of course, be true, but the argument and evidence is not entirely convincing. An example of a country where war was not the driving force would have been helpful.

Another weakness in the book is the case selection. Two of the countries (Japan and China) are examined during a period when neither state had complete control over their customs policy. Furthermore, the time period is similar and both countries were heavily influenced by the western experience of fiscal reform. If China and Japan would have had a full choice set over fiscal policy, would we have seen a different development? Another more or less ignored factor is the possible impact of the dramatically different trade linkages in the late nineteenth century compared with the seventeenth. It is not clear what impact these and other aspects of the case selection have on the conclusions made.

Paths Toward the Modern Fiscal State makes an effective argument regarding the relationship between tax collection and state credit finance. It only advances an interesting theoretical framework, but it also provides exemplary case study evidence.

Wenkai He does a remarkable job in demonstrating the mechanisms involved in three vastly different settings in a way that is graspable even for a scholar not intimately familiar with the histories and institutional structures of England, Japan, and China. While parts of the argument are convincing, the main weakness is the role of warfare. Moreover, it is unclear whether the conclusions drawn are applicable to other cases. What is missing are reflections on the development of modern fiscal states in general, over time and across states.

For scholars mainly interested in European political and economic history, the book places the well-known English case in a new theoretical as well as empirical light. In a broader perspective, the comparison of England, Japan, and China adds a global perspective to a literature where the European experience traditionally has been overrepresented. Scholars interested in the emergence of the modern state as well as the historical development of financial and taxation systems will find the book’s theoretical insights and minute historical detail very informative.

Reviewed by Per Andersson, Lund University

Paths toward the Modern Fiscal State: England, Japan, and China
by Wenkai He
Harvard University Press
Paperback / 304 pages / 2014
ISBN: 9780230299955

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