_“Little else is requisite to carry a state to the highest degree of opulence from the lowest barbarism, but peace, easy taxes, and a tolerable administration of justice; all the rest being brought about by the natural course of things.”_ –attributed to Adam Smith in Stewart (1795)

# **1 Introduction**

State capacity is essential for economic development.<sup>1</sup> The hallmark of countries characterized as “developing,” which distinguishes them from “developed” countries, is the lack of some basic features of state capacity that prosperous societies possess (Besley & Persson, 2011; Herbst, 2000; Migdal, 1988). For example, countries with limited state capacity may lack the ability to raise taxes to finance basic public services, enforce contracts, or protect property rights. International development agencies have thus invested in capacity building projects to strengthen state institutions in developing countries. Although research has established the importance of state capacity in economic development, little is known about how state capacity is built and what is the role of external development partners in this regard (Besley & Persson, 2009; Acemoglu et al., 2015; Fergusson et al., 2020).<sup>2</sup> This paper addresses that gap, providing quantitative results from the evaluation of a typical World Bank project designed to strengthen the capacity of the local state.

Since the 1990s, the World Bank has invested in various projects across regions to strengthen the capacity of the local state (Independent Evaluation Group, 2008, 2018). The core design features are shared by multiple World Bank projects which aim to strengthen local governments across regions. Hence, while this study reports the impacts of such a project in Tanzania, the findings may have implications for how a major global development agency approaches state capacity building projects around the world.

The essential design feature is to provide incentives to local governments to undertake verifiable actions that the project regards as essential for state capacity. These actions include showing 1This statement is both axiomatic in economics as well as one that has recently been supported by rigorous evidence. Modern economics starts with the assumption that state capacity exists to protect property rights, maintain law and order, enforce contracts, and collect the tax revenues needed for these public services (Dincecco & Katz, 2016; Acemoglu, García-Jimeno, & Robinson, 2015; Besley & Persson, 2011) One strand of empirical work finds a robust positive correlation between tax to GDP ratios, and other measures of state capacity, with economic development (Acemoglu, 2005; Besley & Persson, 2009; Dincecco & Katz, 2016). Another strand finds persistent differences in income and prosperity across places which have a history of strong state institutions versus those that do not (Bandyopadhyay & Green, 2016; Gennaioli & Rainer, 2007; Michalopoulos & Papaioannou, 2013).

2Qualitative discussion of whether World Bank projects build state capacity is provided in de Janvry & Dethier (2012) and in Stern, Dethier, & Rogers (2005). Some previous studies have examined the cross-country relationship between World Bank projects and subsequent state capacity, finding a suggestive positive relationship for highly rated projects (Hanson & Sigman, 2019). A recent paper, Erman et al. (2021), uses a fixed effects identification strategy and administrative data on municipal revenues to examine the impact of a project in Mozambique. They find that project municipalities increased own revenue collection over time more than non-project municipalities. In contrast, as we report below, not only do we find no impact of the project in Tanzania on local tax payment and attitudes, but also a striking illustration of how context matters for project design. While the project in Tanzania had initially targeted own-source revenues as a key component of the performance grant, it dropped this component after was re-centralized . Nevertheless, we find evidence of increasing willingness to pay property taxes–a measure of state capacity–in both project and non-project urban local governments in Tanzania.

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