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Explain why onetime redistribution of land is likely to have less negative

effect on saving and investment rate than a redistribution of income period

after period?

The world in which we live is characterised by high degree of inequality. About 80 percent ofthe world assets are captured by top 20 percent of the population. The issue of inequality is

more acute for the developing countries compared to their developed counterparts.

Inequality becomes a subject of concern for the economists and other policy makers not

only for finding the ways to reduce inequality but also because of the functional aspects of

the inter connections between inequality and economic development. Here we make an

attempt to analyse the effects of two major forms of redistribution of land on saving and

investment rate.

Just before we enter into the analysis, we must have certain fundamental insightsdeveloped in mainstream theories of growth and development. Long run rate of savings is

taken as an important proxy for the studies relating to growth and inequality. It is because

rate of savings plays a crucial role in determining the long run per capita income and

thereby economic growth. Keeping this in mind, let us move forward to our specific case.

In a society which is characterised of highly unequal distribution of resources, there may be

strong demand for redistribution of these resources over which a very small portion of the

population has control. Government can take steps for redistribution by adopting one of the

two broader forms.

1. Redistribution of the existing wealth among the broader population (e.g. Landreforms.). If the distribution of land is highly unequal government can confiscate this

land and redistribute it to the peasants and landless labourers.

2. It is possible to have confiscatory taxes that transfer large quantities of non landwealth to the poor which are the redistributed to the poor.

Among these choices, real world experiences show that the first policy is more difficult to

carry out. It needs extra ordinary political will and perfect information about the land

owners and the landless. More over resistance from landlord politicians, vote bankbehaviour of the other land lords and difficulties in putting ceiling on land holdings act as

major constraints for the implementation of this policy.

Faced with these difficulties most governments resort to the second policy in which tax is

levied on the increments to the stock of wealth, rather than the existing wealth base. Thus

as income increases, marginal rate of tax tend to be high (Progressive taxation, which is

considered to be the most redistributive in effect). In addition to this there are excise duties

and sales taxes on the purchase of various products and business profits are also taxed.

These taxes imposed as they are on the margin tend to bring down the rate of investmentand therefore the rate of economic growth. Let us examine why the investment might be

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depressed more with taxes on the margin rather than with lump-sum taxes1 (Lump-sum

taxes have the same effect as the redistribution of the existing wealth such as land reforms)

with the help of the following figure.

Figure 1

Figure 1 depicts an individuals allocation ofher/his existing wealth to consumption in two

periods:- consumption today and tomorrow. The later is achieved by partially desisting from

consuming today and investing te released funds at a given rate of return.

At point A our person is at pre-tax utility level. Now she/he is at indifference curve U0

.

Suppose the government wishes to transfer some of her purchasing power other members

of the society (who are assumed to be poor). To do this, suppose that a tax is imposed on

the return to investment. This has the effect of swivelling the rate of return line downward

as shown in the diagram, so that now the person reaches at point C on the indifferencecurve at U

1.

Now let us consider a lump-sum tax on this individual that pulls her down to exactly the

same indifference curve U1and take this as a case of one time land distribution. In this case

she is at point B. Since both points B and C are on the same indifference curve, it can be

inferred that she is indifferent between the two systems of taxation. It can be seen that

when the person is at point B, she cuts back her current consumption more strongly (look at

the current consumption corresponding to point B and C). Put in another way, we can

understand that the tax on the rate of return reduces the savings relative to lump-sum taxwhich in our case is one time land distribution. Though both lump-sum taxes and income

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taxes have income effects that tend to reduce consumption, the income tax has an

additional price effect that tends to lower the rate of savings and investment.

Conclusion

High levels of inequality may retard economic growth by creating political demand for

redistribution that can only be met by imposing taxes on increments to wealth, and not

existing wealth. Therefore a policy option like land reforms becomes less likely to be opted

by the government for redistribution. The above analysis clearly shoes that one time

redistribution of land is likely to have less negative effect on saving and investment rate

than a redistribution of income period after period. Therefore a onetime land distribution

can be recommended as a policy for growth with equity compared to distribution of income

period after period.

End Notes

1. Lump-sum tax is a onetime tax on wealth. Therefore a onetime redistribution of landessentially has the effect of a lump-sum tax. Income tax is collected period after

period.

Reference

Ray, D. 1999.Development Economics. Oxford University Press, New Delhi