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 of the 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 insights developed 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. Land reforms.). 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 land wealth 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 bank behaviour 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 investment and therefore the rate of economic growth. Let us examine why the investment might be

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 of her/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 indifference curve at U1. Now let us consider a lump-sum tax on this individual that pulls her down to exactly the same indifference curve U1 and 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 tax which in our case is one time land distribution. Though both lump-sum taxes and income

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 land essentially 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