Land taxes and the Zero-Carbon Act

The Zero-Carbon Act means New Zealand is to accelerate the transition to an economy that uses fewer carbon-fossil based energy sources. Given what we know about the problems of global warming, a future in which most energy is renewable is to be welcomed. (As a life-long bicycle commuter, I also hope this future involves fewer cars, to raise the probability I shall live long enough to see it.) 

However, such a transition may require public investment and redistribution to help certain groups who suffer disproportionately from the changes – implying that feasible externality taxes may not be enough. If so there may be a case for land taxes to help fill this gap.

The transition to carbon neutrality

If in the future there are feasible technological alternatives that produce large quantities of low-cost carbon-free energy, which I fully expect, the long-term costs and benefits of this Act will be minor. New Zealanders will simply import the foreign-produced capital equipment to generate this energy, as they have always done, and people will think about carbon fuel sources in much the same way that they think about using candles to light up their homes. 

As part of the transition, the private sector will have to make capital-intensive investments in alternative energy systems, which requires greater savings. The Government may need to make such investments as well, which is likely to require additional taxation. Some of this money may be raised by Pigouvian “pollution-correcting” taxes, although there is no guarantee that these taxes will be sufficiently large to pay for these investments – and they will not be large enough if the goal of zero carbon emissions is achieved. 

In fact, taxes may be needed to be increased for other reasons. During the transition period, the Act will reduce the welfare of those who would benefit materially from cheaper but dirtier energy and who don’t want to reduce their energy consumption. There may be a demand to compensate low income people if the price of energy becomes very high. 

This may not be just a transition problem either. If cheap alternative energy sources do not eventuate in the long term, New Zealanders will less use carbon-based energy which will result in lower material living standards than otherwise. In this case the Act will result in a lot of redistribution from those who would like to use cheaper carbon-based energy to those who prefer fewer carbon emissions. These lower living standards may be perceived as welfare-enhancing given they result in much less greenhouse gas pollution, just as most people are glad petrol is no longer used in petrol. However, there may be a large number of people who resent the limitations the Act places on their material living standards.

If externality taxes aren’t enough, then what can we do?

If more revenue is wanted for green public investments or for redistribution, is there a good way to increase taxes? The “who will pay more taxes?” question always involves a trade-off between equity and efficiency considerations. There is a demand for efficient taxes to ensure the government does not harm the economy too much, and there is a demand for “equitable” taxes to ensure the living standards of those who cannot afford them are not too harshly reduced. 

For years a large majority of economists have noted that urban land taxes are a particularly efficient way to raise revenue, so they are an obvious place to start. They tend to meet most formal “equity” considerations, as well, since the amount of urban land people own or use tends to be increasing in with wealth and (conditional on age) with income. However, this is not the only equity consideration. If taxes on land or on the income from land are used to pay for the transition to a zero carbon economy, there is another delicious implication. 

Financing the transition to a zero-carbon economy is actually a subset of a more general intergenerational question – if an older generation has caused an environmental problem that needs to be cleaned up by young and future generations, who should pay? Frankly, most economists would probably defer on the “should” aspect of the question, but they have worked out that older generations can be made to paid, if society believes they should. The solution is to use urban land taxes to finance the clean-up costs.

The clearest articulation of this principle has been by Antonio Rangel, from CalTech. The argument is relatively simple, and in some sense dates back to Ricardo and Henry George: if you place a tax on land, the price of land falls and so the incidence of the tax falls on the owners of the land at the time the tax is introduced or raised. 

Even though young people and future generations will actually pay the land tax, they will be compensated by lower land prices. Consequently, a large fraction of the burden of the tax will fall on the older generations who were responsible for the pollution problem. But the argument is better than this. If you introduce a land tax, the threat that it will be raised in the future if clean-up costs are higher than expected or pollution targets are not attained increases the incentives of current generations to actually take action to prevent the pollution problem from getting out of hand

This is useful. Urban land taxes are not only an efficient way to raise any taxes associated with the Zero-Carbon Act, but they have “equity” characteristics that suggest they are both efficient and equitable. They could be a “win-win” solution to some of the issues associated with global warming. 

Although it isn’t on the policy agenda right now, there is no reason why it couldn’t be.