Answer to Question #216520 in Microeconomics for Y, Smith

Question

(1). Explain what “equity” means as it relates to taxation.

(2) Discuss the two general equity standards of “benefits received” and “ability to pay.” Explain what each of these terms mean and how each impacts taxation.

(3) Define “horizontal” equity and “vertical" equity and explain how each impacts taxation. .

Answer 1

(1). Taxation equity is the principle that taxes should be fair. However, there are several criteria for determining what is fair. The benefits principle states that people should pay taxes based on the benefits that they receive from government services. For instance, excise taxes on gasoline are used to build roads and bridges. However, taxes on income and investments are based on the ability to pay.

(2).

(i)The Benefits Received Rule or benefits received principle, may take one of two related definitions: one as a tax theory; and one as a tax provision. The two definitions are:

The Benefits Received Principle, which is a theory of income tax fairness that says people should pay taxes based on the benefits they receive from the government.1

A tax provision that says a donor who receives a tangible benefit from making a charitable contribution must subtract the value of that benefit from the amount claimed as an income tax deduction.

(ii)Ability to pay is an economic principle that states that the amount of tax an individual pays should be dependent on the level of burden the tax will create relative to the wealth of the individual. The ability to pay principle suggests that the real amount of tax paid is not the only factor that has to be considered and that other issues such as the ability to pay should also be factored into a tax system.

(3).

Horizontal equity is an economic theory that states that individuals with similar income and assets should pay the same amount in taxes. Horizontal equity should apply to individuals considered equal regardless of the tax system in place. The more neutral a tax system is the more horizontally equitable it is considered to be.

The basis behind the theory of horizontal equity is that people should be treated the same by imposing the same level of income tax to people in the same income group.

Vertical equity is a method of collecting income tax in which the tax rate one is subject to increases with the amount of earned income. The principle behind vertical equity is that those who have the ability to pay more taxes should contribute more than those who are not.

Vertical equity, on the other hand, is associated with the redistribution of wealth and encourages a tax system in which high-income earners, or those with access to more resources, pay more tax than low-income earners.