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Definition: Ability to Pay Taxation
Ability to pay taxation is a type of progressive tax, in which the theory says that people should pay taxes according to what they earn. It depends on the ‘ability’ on what an individual can pay. This is one of the theories that decide how a person should pay and what percentage. For example, a person who earns more money should pay more taxes and the one who earns less should pay less.
The revenue earned by government using ability-to-pay taxation policy is used in defense, roads construction, public health etc. This is one of the two taxation principles, the other one is the benefit principle.
Taxes are a way of transferring money from individuals to government so that the government can use it for public welfare. Government uses it for providing services to the public and for various other operations. The basis for Ability-to-pay principle is to tax only those people who have income. The benefits provided by the government are used by all so accordingly everybody should be taxed for using that. But not everybody can pay taxes; hence those who can afford to pay more should contribute more percentage of their income in taxes than others.
The Ability-to-pay taxation principle also has two types of equities in it. It is fair that those earning the same amount of income should pay the same taxes and those earning different should be taxed differently. This is known as horizontal and vertical equity.
• Horizontal Equity: People having the same income should pay the same amount of taxes. For example: if a vegetable vendor is earning $10000 and taxed $1000 i.e. 10% then an ice-cream seller who is earning $10000 should also be taxed the same percentage i.e. 10%.
• Vertical Equity: People having different incomes should be taxed differently. A person earning $5000 and another person earning $10000 should pay different amount of taxes.
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