Vertical equity is a taxation principle where the amount of taxes paid increases with the amount of earned income. This system ensures that individuals who have a higher ability to pay contribute more in taxes compared to those with lower incomes.
This contrasts with horizontal equity, which posits that individuals with similar income and assets should pay the same amount in taxes.
Understanding Vertical Equity
The equity of a tax system reflects how fairly the tax burden is distributed among individuals. The ability to pay principle underpins both vertical and horizontal equity. Essentially, it states that the taxes paid should reflect the individual’s financial capacity. Vertical equity emphasizes that those with higher incomes should pay more taxes, implemented through proportional or progressive tax rates.
In proportional taxation, individuals pay a consistent proportion of their income in taxes, regardless of earnings. Consequently, those with higher incomes ultimately pay more in dollar amounts.
Key Takeaways
- Vertical equity ensures that more taxes are paid as income increases.
- It is grounded in the principle of ability to pay, utilizing progressive or proportional taxation.
- Achieving vertical equity is often simpler than horizontal equity, as the latter can be hindered by loopholes and deductions.
Example of Vertical Equity
Consider two taxpayers: one earning $100,000 per year and another earning $50,000. With a flat, proportional tax rate of 15%, the higher-income earner would pay $15,000 in taxes, while the lower-income earner would pay $7,500. Although both faces the same tax rate, the dollar amount paid increases with income.
Progressive Taxation
Progressive taxation employs tax brackets, meaning taxes are calculated based on the income bracket an individual falls into. Each bracket has a different tax rate, with higher brackets having higher rates. As a result, effective average tax rates increase with income, ensuring that high earners pay a larger portion of their income in taxes than lower earners.
For example, in the United States, a single taxpayer earning $100,000 might face a top marginal tax rate of 24%, resulting in a tax liability of $18,174.50, with an effective tax rate of 18.17%. Conversely, a single taxpayer earning $50,000 would face a top marginal tax rate of 22% and a tax liability of $6,864, with an effective tax rate of 13.73%.
Even though horizontal equity propounds that individuals in similar income groups should pay the same taxes, this proves difficult due to loopholes, deductions, and incentives within the tax system. Therefore, achieving horizontal equity can be quite complicated.
Related Terms: horizontal equity, proportional taxation, ability to pay.
References
- Internal Revenue Service. “IRS Provides Tax Inflation Adjustments for Tax Year 2022”.
