Land taxation can reduce wealth inequality

“Of course, opinions on distributional justice differ a lot. However, even if one only slightly dislikes the idea of unequal distribution of wealth, using taxes on land rent is a really good choice for government policy. Taxing land while reducing capital taxes can enhance welfare and at the same time increase economic efficiency and sustainability”, says Ottmar Edenhofer, coauthor and Director of the Potsdam Institute for Climate Impact Research (PIK) as well as of the Mercator Research Institute on Global Commons and Climate Change.

The authors of the study examined how governments can use the “portfolio effect” to reduce wealth inequality. This effect, pioneered by Martin Feldstein in 1977, demonstrates that taxing land rents fuels investments in productive capital. Under land rent taxes, investors redirect financial flows from land to capital investments, thus increasing the capital stock. Demand for land falls, but this affects only land prices and not the available quantity. Hence, the economy grows.

Although land has been shown to be a key determinant of wealth accumulation, it is still largely absent in current research on optimal taxation. The new paper fills this gap by studying optimal redistributive taxation in a model with land as second asset class for investments next to capital.

"People with little or no wealth would benefit from land taxes in three ways"

“For the first time, we ask the question whether the portfolio effect of taxing land rents is also good for distributional justice”, explains lead author Max Franks from PIK. “One aspect is that land rent taxation reduces speculation in real estate, which can slow the rapid rise in real estate prices. People with little or no wealth would benefit from land taxes in three ways: Housing costs rise less rapidly and land grabbing becomes less attractive, potentially higher tax revenues from the land tax can go as transfers to poor households and the investments create jobs and potentially raise wages.”

Practical challenges of the implementation of land rent taxation remain: Especially the political economy of compensation for the losers of a land rent tax like middle-class house owners still needs to be explored. However, there are already communities, e. g. in Pennsylvania and Singapore, where public transport and other types of infrastructure have been successfully financed through land rent taxation. The authors recommend that these examples from practice should be researched in more detail. They hold important lessons for reducing wealth inequality, but also with respect to climate change mitigation. By expanding public transport, for example, carbon emissions in the transport sector can be reduced.