Ability-To-Pay Taxation Definition

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Ability-To-Pay Taxation Definition

What Is Ability-To-Pay Taxation?

The capacity-to-pay taxation ideology holds that taxes should be assessed based on a taxpayer’s ability to pay. The notion is that higher-income individuals, firms, and corporations can and should pay more in taxes.

Key Takeaways

  • According to the capacity-to-pay concept, individuals with a better ability to pay taxes (as measured by income and wealth) should pay more.
  • One concept behind “capacity to pay” is that individuals who have achieved success should be ready to give back a bit more to the society that helped them achieve it.
  • Proponents of “capacity to pay” believe that since a single dollar means less to a wealthy person than it does to a wage employee, the affluent should pay more to compensate for their sacrifice.

Understanding the Ability-To-Pay Principle

The ability-to-pay taxation theory contends that people with higher earnings should pay a larger proportion of their income in taxes than those with lower incomes. Individuals in the United States with taxable income less than $9,875 paid a 10% income tax rate in 2020, while those with taxable income more than $518,000 faced a 37% rate, the nation’s highest individual rate. Earnings between such levels are taxed at the rates determined by income brackets.

The principle behind ability-to-pay taxation is that everyone should make an equal sacrifice when it comes to paying taxes, and since individuals with more money have less need for a particular dollar, paying more of it in taxes does not impose a heavier hardship. Consider this: $10,000 will make very little difference in the life of someone making $1 million per year, but it will make a significant impact in the life of someone earning just $60,000 per year.

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History of Ability-to-Pay Taxation

The concept of a progressive income tax—that persons with greater income should pay a bigger proportion of their income—is centuries old. In reality, Adam Smith, often regarded as the founder of economics, advocated it in 1776.

“The subjects of every state ought to pay to the maintenance of the government, as nearly as practicable, in proportion to their respective talents; that is, in proportion to the income which they respectively receive under the protection of the state,” Smith stated.

Arguments for Progressive Taxation

Advocates of ability-to-pay taxes say that individuals who have benefited the most from the nation’s way of life, as measured by increased earnings and wealth, can afford and should be compelled to contribute a bit more to keep the system going.

The argument is that the society that government tax income has helped to build—infrastructure such as motorways and fiberoptic communications networks, a strong military, public schools, and a free market system—provides an environment in which their success is conceivable and can be sustained.

Criticism of Ability-to-Pay Taxation

Progressive taxation is seen as inherently unjust by critics. They argue that it penalizes hard effort and accomplishment while decreasing the motivation to earn greater money. Many say that in order to make the system more egalitarian, everyone should pay the same income tax rate—a “flat tax.”

Progressive Taxation and Inequality

While the United States currently has a progressive tax system, tax rates for the wealthy have decreased over the last few decades. When President Ronald Reagan entered office in 1981, the highest individual income tax level was 70%. In 2020, the highest income rate will be 37%. Meanwhile, inequality has reached unprecedented heights in at least a century. The richest 1% currently controls more money than the bottom 90% combined.

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