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We develop a dynamic political economy model in which investment in the state capacity to levy taxes and deter crime is a policy variable, and we study the evolution of state capacity when policy is chosen by an elite. We show that democratization in the sense of expansion of the elite leads to an increased investment in state capacity and to a reduction in illegal activities and has nonmonotonic effects on tax rates as it reduces the willingness of the elite to engage in particularistic spending but enhances its willingness to provide public goods. Depending on initial conditions, consensual political changes may lead either to democratization or to the entrenchment of an immovable elite. Copyright Springer-Verlag 2013