# The Effect of Local State Capacity on the Efficiency of Service Provision Systems in Education and Water

## The Model for Enrollment Rates and Quality of Education

As already mentioned, we suggest that higher fiscal effort of local governments should reflect itself in higher level of public goods provision. In this case, we expect that when the citizens pay their dues they are in a better position to demand that the administration respond to their most urgent needs, and, in turn, the administration should be able to maximize its electoral advantage by responding to its electorate. We first address the education sector.

Then, the influence of the fiscal effort on the educational indicators is estimated using the following model:

where *Y _{if}* represents an educational outcome—enrollment rates or quality of education—and the expressions on the right are the explanatory variables. The symbol

*в*

_{i}stands for the municipal fixed effects, while

*T*are year dummies. It is expected that a

_{t}_{1}> a

_{2}and ai >

*a*as the efficiency of the locally raised funds should be greater than the efficiency of the central government transfers and royalties.

_{3}Nevertheless, the coefficient a_{1} may be biased as both local taxes and the educational indicators may be related to the omitted variables that change over time and hence are not fully captured by the municipal fixed effects. One example of an omitted variable, for instance, is the price of local production that may affect both local taxes through larger economic activity and educational outcomes of such enrollment rates. In order to correct the likely bias in the estimator we instrument the tax capacity variable. The instrumental variable used is the estimated undervaluation of the properties of the local cadastre, explained above. Such undervaluation depends exclusively on the frequency and number of cadastral updates.

Conceptually, undervaluation is not related to the educational outcomes; it is only through greater tax capacity that a municipality may attain it when its tax base is enhanced by an administrative action.

Therefore, the first stage of the educational outcome equation is done using the following equation:

It is then expected that *y _{1}* < 0 since an increase in the undervaluation for properties would reduce both the property and land tax base and, consequently, the potential tax collection.

## The Model for Coverage and Quality of Water

As in the case of education, the estimated model lets us determine the impact of the fiscal effort and the structure of the water sector on the indicator of coverage and quality of water at the municipal level. In the case of water coverage, we use census data for 2005 at the municipal level, and hence the models to be estimated are cross-section ordinary least squares (OLS) and instrumental variable ones. Thus, the model has the following structure:

where *W _{i}* stands for water coverage in 2005. For the rest of the variables we computed their average for the period 1994-2005. The variable EICEs expresses whether water is provided by a government-owned company, ESP expresses whether it is provided by a mixed or private firm, and year- since-reform stands for the number of years during which the EICEs or the ESP has been delivering the service.