Horizontal equity
From CEOpedia | Management online
| Horizontal equity |
|---|
| See also |
Horizontal equity is a concept of taxation which states that taxpayers with similar incomes should pay similar amounts of taxes. In other words, it is an economic theory that people with the same financial resources should pay the same amount of taxes to the government, regardless of their job or their location. This is the opposite of vertical equity which states that those with higher incomes should pay proportionately more taxes than those with lower incomes.
To achieve horizontal equity, governments often use flat rates, which means that all taxpayers with the same level of income pay the same rate of tax. For example, a flat rate of 10 percent means that all taxpayers who earn $10,000 pay $1,000 in taxes, while those who make $100,000 would also pay $10,000 in taxes. This is in contrast to the progressive tax system, which uses graduated rates which increase as a person's income increases.
Example of Horizontal equity
- Flat tax rate: A flat tax rate is a single rate of taxation that applies to all taxpayers regardless of their income level. For example, if the flat rate of taxation is 10%, then all taxpayers who earn $10,000 would pay $1,000 in taxes, while those who make $100,000 would pay $10,000 in taxes.
- Uniform tax rate: A uniform tax rate is a rate of taxation that is applied to all taxpayers within a specific geographical area. For example, if the uniform rate is 10%, then all taxpayers living in the same city or town would pay the same rate of taxation, regardless of their income level.
- Proportional tax rate: A proportional tax rate is a rate of taxation that is applied to all taxpayers regardless of their income level. For example, if the proportional rate of taxation is 10%, then all taxpayers who earn $10,000 would pay $1,000 in taxes, while those who make $100,000 would pay $10,000 in taxes.
When to use Horizontal equity
- Horizontal equity is most commonly used when governments are trying to ensure fairness in the tax system and when they are trying to ensure that all taxpayers contribute the same amount of taxes regardless of their income level.
- It is also used to ensure that those with lower incomes are not taxed at a higher rate than those with higher incomes, as this could lead to an unfair system of taxation.
- Additionally, horizontal equity can be used to encourage economic growth, as taxpayers may be more willing to invest in the economy when they know that their taxes will be the same as everyone else's.
Types of Horizontal equity
There are three main types of horizontal equity: proportional, equal, and progressive.
- Proportional equity states that everyone should pay the same proportion of their income in taxes, regardless of their income level. For example, someone who makes $10,000 would pay 10% of their income in taxes, while someone who makes $100,000 would pay 10% of their income in taxes.
- Equal equity states that everyone should pay the same amount of taxes, regardless of their income level. For example, everyone who makes $10,000 would pay $1,000 in taxes, while everyone who makes $100,000 would pay $10,000 in taxes.
- Progressive equity states that those with higher incomes should pay proportionately more taxes than those with lower incomes. This is achieved by using graduated tax rates, which increase as a person's income increases. For example, someone who makes $10,000 would pay 10% of their income in taxes, while someone who makes $100,000 would pay 15% of their income in taxes.
Steps of Horizontal equity
- Step 1: Identify the Tax Base: The first step in achieving horizontal equity is to identify the tax base, which can be any type of income or asset, including wages, investments, and property ownership.
- Step 2: Set the Tax Rate: After identifying the tax base, the government will set the rate of taxation. This is usually done using a flat rate system, in which all taxpayers with the same level of income will pay the same rate of tax.
- Step 3: Establish Tax Credits or Deductions: The government may also offer tax credits or deductions for certain types of income or expenses, such as education or medical expenses. This helps to ensure that all taxpayers are treated fairly, regardless of their financial situation.
- Step 4: Calculate the Tax Liability: Once the tax rate, base, and credits or deductions have been established, the government will then calculate the tax liability for each taxpayer. This is usually done by multiplying the taxable income by the tax rate, and then subtracting any applicable credits or deductions.
Advantages of Horizontal equity
- Fairness: One of the primary advantages of horizontal equity is that it is considered fair as it ensures that people with the same incomes pay the same amount of taxes. This ensures that people with different jobs and from different locations are all treated the same, which is seen as an important part of a fair taxation system.
- Simplicity: Horizontal equity is also seen as simpler than other forms of taxation, as the tax rate is applied uniformly to everyone regardless of their income. This means that there is no need to keep track of different rates or brackets, which simplifies the taxation process.
Limitations of Horizontal equity
Despite its advantages, horizontal equity does have its limitations.
- Firstly, it ignores the ability of taxpayers to pay. This means that those with the same incomes may not have the same financial resources, and may therefore not be able to pay the same amount of taxes.
- Secondly, it fails to take into account the needs of taxpayers. Those with lower incomes may have greater financial needs and be unable to pay the same amount of taxes as those with higher incomes.
- Finally, it doesn't account for the fact that people can use deductions and other strategies to reduce their taxable incomes, which means that those with higher incomes may end up paying less in taxes than those with lower incomes.
There are several other approaches to taxation that are related to the concept of horizontal equity. These include:
- Proportional Taxation: This approach taxes all taxpayers at the same rate, regardless of their income level. This means that everyone pays the same rate of tax, regardless of how much they earn.
- Regressive Taxation: This approach increases the tax rate for people with higher incomes. Therefore, those with lower incomes pay a lower rate of tax, while those with higher incomes pay higher rates of tax.
- Progressive Taxation: This approach is the opposite of regressive taxation, and increases the tax rate for people with higher incomes. This means that those with lower incomes pay a lower rate of tax, while those with higher incomes pay higher rates of tax.
In summary, there are several approaches to taxation that are related to horizontal equity, including proportional taxation, regressive taxation, and progressive taxation. Each approach taxes people at different rates depending on their income level.
Suggested literature
- Auerbach, A. J., & Hassett, K. A. (2002). A new measure of horizontal equity. American Economic Review, 92(4), 1116-1125.
- Elkins, D. (2006). Horizontal equity as a principle of tax theory. Yale L. & Pol'y Rev., 24, 43.
