Ability-to-Pay Principle

The ability-to-pay principle is a taxation theory that requires the total tax burden to be distributed to individuals depending on their own ability to bear it.

The common forms of taxes in ability-to-pay principle of taxation include income, inheritance taxes, net worth, and consumption.

History shows that there was an agreement that any income generated by an individual is the best indicator of their ability to pay.

However, this means that taxes will be deducted according to their income.

A number of scholars presented a new perspective on this concept. They proposed that, for equity purposes, the ability to pay should be measured by what you spend and not what you make.

Modern economists also believe that the more you save the stronger the economy becomes, and, in return, you will have the ability to live a better life.

The consumption taxation emphasizes on the neutrality of the consumption-based taxes.

Although there are other principles of taxation, the ability to pay principle is the most common measure.

Example

For you to better understand the ability-to-pay principle of taxation, taxes should be based on the amount of money you earn.

For people who earn more, they should be taxed more, meaning that a higher proportion of their income is taxed.

On the other hand, if you earn less, the tax rate should be lower and pay less tax.

However, the government requires you to pay for additional services such as road, governance, school, and police tax.

The ability-to-pay principle does not take into consideration the amount that taxpayers pay for such services.

Arguments in Favor of The Ability-to-Pay Principle	Arguments Against The Ability-to-Pay Principle
When your income is average, you tend to spend rationally. However, this is not the case for wealthier people where their income exceeds necessity. Wealthy individuals derive very little satisfaction or marginal utility for any additional money spent. The value of the currency reduces for the wealthy people as they spend more. When you are charged progressive taxes, following the ability-to-pay principle, the government can meet its revenue needs and tax evasion reduces drastically. The marginal utility per dollar, or any local currency, falls for the poor person. However, the value of the currency is much higher for this class of people than it is with wealthier citizens. This means that when wealthier people are charged more, and the poor charged less tax, it brings equality in society.	It is difficult for the government to determine the ability of an individual to pay taxes. The ability to pay an ambiguous principle leads to disagreement should taxpayers should be charged a uniform percentage throughout depending on their income. You should pay taxes to the extent of use of the public facilities or public goods and services and not as a generality. The government requires all people to pay taxes in order to provide different services, even for goods and services that they do not use. Marginal utility of the currency falls for the high earners and it increases for the low-income earners, which brings disparity.

Arguments in Favor of
The Ability-to-Pay Principle

Arguments Against
The Ability-to-Pay Principle

When your income is average, you tend to spend rationally. However, this is not the case for wealthier people where their income exceeds necessity.
Wealthy individuals derive very little satisfaction or marginal utility for any additional money spent. The value of the currency reduces for the wealthy people as they spend more.
When you are charged progressive taxes, following the ability-to-pay principle, the government can meet its revenue needs and tax evasion reduces drastically.
The marginal utility per dollar, or any local currency, falls for the poor person. However, the value of the currency is much higher for this class of people than it is with wealthier citizens. This means that when wealthier people are charged more, and the poor charged less tax, it brings equality in society.

It is difficult for the government to determine the ability of an individual to pay taxes.
The ability to pay an ambiguous principle leads to disagreement should taxpayers should be charged a uniform percentage throughout depending on their income.
You should pay taxes to the extent of use of the public facilities or public goods and services and not as a generality. The government requires all people to pay taxes in order to provide different services, even for goods and services that they do not use.
Marginal utility of the currency falls for the high earners and it increases for the low-income earners, which brings disparity.

Disclaimer: The contents of this article are for informational and entertainment purposes only and should not be construed as financial advice or recommendations to buy or sell any securities.

What's More?

Capital Intensity Ratio

Price Elasticity of Supply (PES)

Economic Value Added (EVA)

Shareholder Value Added (SVA)

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Ability-to-Pay Principle

​Example

Example