Ability-to-Pay Principle

Ability-to-Pay principle is principle of taxation which asserts that the amount of tax
levied on an economic entity should be directly proportional to the ability of the
entity to pay taxes. Therefore, a person having high income and wealth should be
taxed more and less tax should be levied on those having low income and wealth
provided other things remain constant.

Examples
Any taxes that result in higher tax being charged on high income or wealth, either
proportionally i.e. same percentage on income and wealth or progressively i.e. low
percentage on lower income/wealth and high percentage on higher income or
wealth, are according to ability-to-pay principle. Examples include most personal
and corporate income taxes and property taxes.

Arguments in favor of ability-to-pay principle are:

The amount of money available to wealthier people far exceeds their basic
necessities and since an average consumer acts rationally, wealthier people derive
less and less additional satisfaction (marginal utility) from an additional Dollar
spent. In other words, the value of a dollar for a wealthy person reduces as they
spend more. The marginal utility per Dollar for a poor person also falls however, it is
still much higher than that of a wealthier person. This means that if equal nominal
taxes were charged, it will cause unfairly high utility sacrifice for a poor person than
for a wealthier person. To equalize to the utility sacrifice caused by taxes, poor
people should pay less and wealthier should pay more.
Progressive taxes, which follow ability-to-pay principle, can quickly fulfill the
revenue needs of a government and also result in more revenue for government,
provided there is no tax evasion.

Arguments against the ability-to-pay principle are:

It is difficult if not impossible to determine the ability of a person to pay taxes. The
term 'ability-to-pay' is ambiguous. It leads to questions such as: should the taxes be
charged at a uniform percentage for all taxpayers or is it going to be a higher
percentage on high income and low percentage on low income?
Taxes allow the government to offer public goods and services and the users of
those goods and services should pay taxes according to extent to which they use
public goods and services and not on the basis of how much they have earned.

While the discussion between horizontal and vertical equity generally applies to tax
policy, we can also look at the class economics definition for the two terms and go
over a few examples.

Horizontal equity means that we apply the exact same policy to people in the
same situation. For example if two people earn both earn $25,000 per year they
should both pay the same amount of tax. This means that if we have horizontal
equity, we try to make sure that we do not make decisions based on non-income
characteristics like ethnicity, gender, weight, sexual orientation, or job status.
Vertical Equity means that people with higher incomes should be required to pay
more tax. The purpose of vertical equity is to to tax in a more progressive way. It
goes by the principle that people with more ability to pay should pay more. The
point of vertical equity is to redistribute wealth in the society in a more fair way,
which implies that poor people get more happiness out of money than the rich do.
Horizontal equity is a must for most tax systems because citizens can become very
upset if they are required to pay higher taxes based on non-financial characteristics
such as marriage. Before the recent reform, married couples filing together in the
United States paid more in taxes than an identical married couple would by filing
separately. Consider the following example of horizontal equity:
John and Jane file together, and make 50K each. Because together they earn 100K,
they fall into the 20% tax bracket, and pay 20K in taxes. While Adam and Alice file
separately, because they each 50K each, they fall in the 10% tax bracket, and pay
only 10K in taxes total. Because these people are in identical situations but pay
different tax amounts, we see a violation of the horizontal equity principle.
What the recent tax reform did was raise the amount of income allowed by married
couples, so that people in John and Janes situation would pay an identical amount
to couples in Adam and Alices situation. This results in horizontal equity.
An example of a violation of vertical equity is a tax on food. Generally people (both
rich and poor) will buy a similar amount of food each month. This means that both
rich and poor will pay the same amount of tax on their food purchases. This
violates the vertical equity principle because those who are able to pay more are
not required to.
An example of vertical equity is the progressive federal income tax system in the
United States. As someone earns more money, they have to pay a higher
percentage of their income in taxes. While those with low incomes, pay lower
percentages of their income in tax, or perhaps pay no tax at all.

Horizontal and Vertical Equity

When looking at tax "fairness", we typically look at two different goals in
distributions to look at equity; vertical and horizontal equity.
Horizontal Equity
This principle claims that there is "equal treatment of equals." In other words,
individuals who have the same wealth, or are in the same income bracket, should
face the same tax rate.

Vertical Equity
This principle claims that wealthier people, or those with access to more resources,
should pay higher taxes.
Taxes are classified as being Progressive, Proportional, or Regressive. These
designations focus on the relationship between tax rates and income simply
because all taxes, regardless of whether they are levied on income or on a product
or building or parcel of land are ultimately paid out of someone's income.
Progressive Tax
A tax is progressive if its average rate increases as income increases. Such a tax
claim not only a larger absolute amount, but also a larger fraction or percentage of
income as income increases. Now say the rate structure is such that the household
with an annual taxable income of less than $10,000 pays 5% in income taxes, the
household realizing an income of $10,000 to $20,000 pays 10%, $20,000 to
$30,000 pay 15%, and so forth. This would be a progressive income tax.
Regressive Tax
A regressive tax is one whose average rate declines as income increases. Such a tax
takes a smaller and smaller proportion of income as income increases. A regressive
tax may or may not take a larger absolute amount of income as income expands. in
this case, you pay 15% if you earn less than $10,000; 10% if you earn $10,000 to
$20,000; 5% if you earn $20,000 to $30,000 and so on. This is a regressive income
tax.
Proportional Tax
A tax is proportional when its average rate remains the same, regardless of the size
of income. Suppose tax rates are such that a household pays 10% of its income in
taxes, regardless of the size of its income. This would be a Progressive Tax.

DEFINITION of 'Tax Fairness'

A tax platform based on an ideal that aims to create a system of taxation that is
fair, clear and equivalent for all taxpayers. Overall, tax fairness looks to limit the
amount of tax legislation and rules that benefit one segment of the tax-paying
population over another.
Many groups, politicians and individuals that push for tax fairness are looking to
remove loopholes, incentives and cheating within the tax system. Tax fairness
supporters believe these practices place an undue tax burden on certain segments
of the tax-paying population, while making it easy for other segments to
significantly lower their tax burdens.
Pay as you go - system or practice of paying debts as they are incurred.
the principle or practice of paying for goods and services at the time of purchase,
rather than relying on credit.

Marginal utility
In economics, the marginal utility of a good or service is the gain from an increase,
or loss from a decrease, in the consumption of that good or service. Economists
sometimes speak of a law of diminishing marginal utility, meaning that the first unit
of consumption of a good or service yields more utility than the second and
subsequent units, with a continuing reduction for greater amounts[clarification
needed]. The marginal decision rule states that a good or service should be
consumed at a quantity at which the marginal utility is equal to the marginal cost.
[1]

Marginality
The term marginal refers to a small change, starting from some baseline level. As
Philip Wicksteed explained the term,
"Marginal considerations are considerations which concern a slight increase or
diminution of the stock of anything which we possess or are considering"[2]
Frequently the marginal change is assumed to start from the endowment, meaning
the total resources available for consumption (see Budget constraint). This
endowment is determined by many things including physical laws (which constrain
how forms of energy and matter may be transformed), accidents of nature (which
determine the presence of natural resources), and the outcomes of past decisions
made by the individual himself or herself and by others.

For reasons of tractability, it is often assumed in neoclassical analysis that goods

and services are continuously divisible. Under this assumption, marginal concepts,
including marginal utility, may be expressed in terms of differential calculus.
Marginal utility can then be defined as the first derivative of the total satisfaction
obtained from consumption of a good or service, with respect to the amount of
consumption of that good or service.
In practice the smallest relevant division may be quite large. Sometimes economic
analysis concerns the marginal values associated with a change of one unit of a
discrete good or service, such as a motor vehicle or a haircut. For a motor vehicle,
the total number of motor vehicles produced is large enough for a continuous
assumption to be reasonable: this may not be true for, say, an aircraft carrier.

Utility
Depending on which theory of utility is used, the interpretation of marginal utility
can be meaningful or not. Economists have commonly described utility as if it were
quantifiable, that is, as if different levels of utility could be compared along a
numerical scale.[3][4] This has affected the development and reception of theories
of marginal utility. Quantitative concepts of utility allow familiar arithmetic
operations, and further assumptions of continuity and differentiability greatly
increase tractability.
Contemporary mainstream economic theory frequently defers metaphysical
questions, and merely notes or assumes that preference structures conforming to
certain rules can be usefully proxied by associating goods, services, or their uses
with quantities, and defines "utility" as such a quantification.[5]
Another conception is Benthamite philosophy, which equated usefulness with the
production of pleasure and avoidance of pain,[6] assumed subject to arithmetic
operation.[7] British economists, under the influence of this philosophy (especially
by way of John Stuart Mill), viewed utility as "the feelings of pleasure and pain"[8]
and further as a "quantity of feeling" (emphasis added).[9]
Though generally pursued outside of the mainstream methods, there are
conceptions of utility that do not rely on quantification. For example, the Austrian
school generally attributes value to the satisfaction of needs and sometimes rejects
even the possibility of quantification.[13] It has been argued that the Austrian
framework makes it possible to consider rational preferences that would otherwise
be excluded.
In any standard framework, the same object may have different marginal utilities for
different people, reflecting different preferences or individual circumstances.[14]

Diminishing marginal utility

The concept that marginal utilities diminish across the ranges relevant to decisionmaking is called the "law of diminishing marginal utility" (and is also known as
Gossen's First Law). This refers to the increase in utility an individual gains from
increase in the consumption of a particular good. "The law of diminishing marginal
utility is at the heart of the explanation of numerous economic phenomena,
including time preference and the value of goods... The law says, first, that the
marginal utility of each homogenous unit decreases as the supply of units increases
(and vice versa); second, that the marginal utility of a larger-sized unit is greater
than the marginal utility of a smaller-sized unit (and vice versa). The first law
denotes the law of diminishing marginal utility, the second law denotes the law of
increasing total utility."
The law of diminishing marginal utility is similar to the law of diminishing returns
which states that as the amount of one factor of production increases as all other
factors of production are held the same, the marginal return (extra output gained by
adding an extra unit) decreases.

As the rate of commodity acquisition increases, marginal utility decreases. If

commodity consumption continues to rise, marginal utility at some point may fall to
zero, reaching maximum total utility. Further increase in consumption of units of
commodities causes marginal utility to become negative; this signifies
dissatisfaction. For example, beyond some point, further doses of antibiotics would
kill no pathogens at all, and might even become harmful to the body.to satiate thirst
a person drinks water but beyond a point consumption of more water might make
the person vomit,hence leading to diminishing marginal utility it takes a certain
amount of food energy to sustain a population, yet beyond a point, more calories
cannot be consumed and are simply discarded (or cause disease).
Diminishing marginal utility is traditionally a microeconomic concept and often
holds for an individual. For an individual, the marginal utility of a good or service
might actually be increasing. For example:
bed sheets, which up to some number may only provide warmth, but after
that point may be useful to allow one to effect an escape by being tied
together into a rope;tickets, for travel or theatre, where a second ticket might
allow one to take a date on an otherwise uninteresting outing;
dosages of antibiotics, where having too few pills would leave bacteria with
greater resistance, but a full supply could effect a cure.
the third leg is more useful than the first two when building a chair.

As suggested elsewhere in this article, occasionally one may come across a

situation in which marginal utility increases even at a macroeconomic level. For
example the provision of a service may only be viable if it accessible to most or all
of the population, and the marginal utility of a raw material required to provide such
a service will increase at the "tipping point" at which this occurs. This is similar to
the position with very large items such as aircraft carriers: the numbers of these
items involved are so small that marginal utility is no longer a helpful concept, as
there is merely a simple "yes" or "no" decision.
BOSTON TEA PARTY
The Boston Tea Party (initially referred to by John Adams as "the Destruction of
the Tea in Boston"[2]) was a political protest by the Sons of Liberty in Boston, on
December 16, 1773. The demonstrators, some disguised as American Indians,
destroyed an entire shipment of tea sent by the East India Company, in defiance of
the Tea Act of May 10, 1773. They boarded the ships and threw the chests of tea
into Boston Harbor, ruining the tea. The British government responded harshly and
the episode escalated into the American Revolution. The Tea Party became an iconic
event of American history, and other political protests such as the Tea Party
movement after 2010 explicitly refer to it.
The Tea Party was the culmination of a resistance movement throughout British
America against the Tea Act, which had been passed by the British Parliament in
1773. Colonists objected to the Tea Act because they believed that it violated their
rights as Englishmen to "No taxation without representation," that is, be taxed only
by their own elected representatives and not by a British parliament in which they
were not represented. Protesters had successfully prevented the unloading of taxed
tea in three other colonies, but in Boston, embattled Royal Governor Thomas
Hutchinson refused to allow the tea to be returned to Britain.
The Boston Tea Party was a key event in the growth of the American Revolution.
Parliament responded in 1774 with the Coercive Acts, or Intolerable Acts, which,
among other provisions, ended local self-government in Massachusetts and closed
Boston's commerce. Colonists up and down the Thirteen Colonies in turn responded
to the Coercive Acts with additional acts of protest, and by convening the First
Continental Congress, which petitioned the British monarch for repeal of the acts
and coordinated colonial resistance to them. The crisis escalated, and the American
Revolutionary War began near Boston in 1775.
Background
Plaque affixed to side of the Independence Wharf building (2009)
The Boston Tea Party arose from two issues confronting the British Empire in 1765:
the financial problems of the British East India Company; and an ongoing dispute
about the extent of Parliament's authority, if any, over the British American colonies

without seating any elected representation. The North Ministry's attempt to resolve
these issues produced a showdown that would eventually result in revolution.
Tea trade to 1767
As Europeans developed a taste for tea in the 17th century, rival companies were
formed to import the product from China.[4] In England, Parliament gave the East
India Company a monopoly on the importation of tea in 1698.[5] When tea became
popular in the British colonies, Parliament sought to eliminate foreign competition
by passing an act in 1721 that required colonists to import their tea only from Great
Britain.[6] The East India Company did not export tea to the colonies; by law, the
company was required to sell its tea wholesale at auctions in England. British firms
bought this tea and exported it to the colonies, where they resold it to merchants in
Boston, New York, Philadelphia, and Charleston.[7]
Until 1767, the East India Company paid an ad valorem tax of about 25% on tea
that it imported into Great Britain.[8] Parliament laid additional taxes on tea sold for
consumption in Britain. These high taxes, combined with the fact that tea imported
into the Dutch Republic was not taxed by the Dutch government, meant that Britons
and British Americans could buy smuggled Dutch tea at much cheaper prices.[9]
The biggest market for illicit tea was Englandby the 1760s the East India Company
was losing 400,000 per year to smugglers in Great Britain[10]but Dutch tea was
also smuggled into British America in significant quantities.[11]
In 1767, to help the East India Company compete with smuggled Dutch tea,
Parliament passed the Indemnity Act, which lowered the tax on tea consumed in
Great Britain, and gave the East India Company a refund of the 25% duty on tea
that was re-exported to the colonies.[12] To help offset this loss of government
revenue, Parliament also passed the Townshend Revenue Act of 1767, which levied
new taxes, including one on tea, in the colonies. Instead of solving the smuggling
problem, however, the Townshend duties renewed a controversy about Parliament's
right to tax the colonies.
Townshend duty crisis
Controversy between Great Britain and the colonies arose in the 1760s when
Parliament sought, for the first time, to impose a direct tax on the colonies for the
purpose of raising revenue. Some colonists, known in the colonies as Whigs,
objected to the new tax program, arguing that it was a violation of the British
Constitution. Britons and British Americans agreed that, according to the
constitution, British subjects could not be taxed without the consent of their elected
representatives. In Great Britain, this meant that taxes could only be levied by
Parliament. Colonists, however, did not elect members of Parliament, and so
American Whigs argued that the colonies could not be taxed by that body. According
to Whigs, colonists could only be taxed by their own colonial assemblies. Colonial
protests resulted in the repeal of the Stamp Act in 1766, but in the 1766 Declaratory

Act, Parliament continued to insist that it had the right to legislate for the colonies
"in all cases whatsoever".
When new taxes were levied in the Townshend Revenue Act of 1767, Whig colonists
again responded with protests and boycotts. Merchants organized a non-importation
agreement, and many colonists pledged to abstain from drinking British tea, with
activists in New England promoting alternatives, such as domestic Labrador tea.[14]
Smuggling continued apace, especially in New York and Philadelphia, where tea
smuggling had always been more extensive than in Boston. Dutied British tea
continued to be imported into Boston, however, especially by Richard Clarke and
the sons of Massachusetts Governor Thomas Hutchinson, until pressure from
Massachusetts Whigs compelled them to abide by the non-importation agreement.
Parliament finally responded to the protests by repealing the Townshend taxes in
1770, except for the tea duty, which Prime Minister Lord North kept to assert "the
right of taxing the Americans".[16] This partial repeal of the taxes was enough to
bring an end to the non-importation movement by October 1770.[17] From 1771 to
1773, British tea was once again imported into the colonies in significant amounts,
with merchants paying the Townshend duty of three pence per pound.[18] Boston
was the largest colonial importer of legal tea; smugglers still dominated the market
in New York and Philadelphia.

Tea Act of 1773

The Indemnity Act of 1767, which gave the East India Company a refund of the duty
on tea that was re-exported to the colonies, expired in 1772. Parliament passed a
new act in 1772 that reduced this refund, effectively leaving a 10% duty on tea
imported into Britain.[20] The act also restored the tea taxes within Britain that had
been repealed in 1767, and left in place the three pence Townshend duty in the
colonies. With this new tax burden driving up the price of British tea, sales
plummeted. The company continued to import tea into Great Britain, however,
amassing a huge surplus of product that no one would buy.[21] For these and other
reasons, by late 1772 the East India Company, one of Britain's most important
commercial institutions, was in a serious financial crisis.
Eliminating some of the taxes was one obvious solution to the crisis. The East India
Company initially sought to have the Townshend duty repealed, but the North
ministry was unwilling because such an action might be interpreted as a retreat
from Parliament's position that it had the right to tax the colonies.[23] More
importantly, the tax collected from the Townshend duty was used to pay the salaries
of some colonial governors and judges.[24] This was in fact the purpose of the
Townshend tax: previously these officials had been paid by the colonial assemblies,
but Parliament now paid their salaries to keep them dependent on the British
government rather than allowing them to be accountable to the colonists.[25]

Another possible solution for reducing the growing mound of tea in the East India
Company warehouses was to sell it cheaply in Europe. This possibility was
investigated, but it was determined that the tea would simply be smuggled back
into Great Britain, where it would undersell the taxed product.[26] The best market
for the East India Company's surplus tea, so it seemed, was the American colonies,
if a way could be found to make it cheaper than the smuggled Dutch tea.[27]
The North ministry's solution was the Tea Act, which received the assent of King
George on May 10, 1773.[28] This act restored the East India Company's full refund
on the duty for importing tea into Britain, and also permitted the company, for the
first time, to export tea to the colonies on its own account. This would allow the
company to reduce costs by eliminating the middlemen who bought the tea at
wholesale auctions in London.[29] Instead of selling to middlemen, the company
now appointed colonial merchants to receive the tea on consignment; the
consignees would in turn sell the tea for a commission. In July 1773, tea consignees
were selected in New York, Philadelphia, Boston, and Charleston.[30]
The Tea Act retained the three pence Townshend duty on tea imported to the
colonies. Some members of Parliament wanted to eliminate this tax, arguing that
there was no reason to provoke another colonial controversy. Former Chancellor of
the Exchequer William Dowdeswell, for example, warned Lord North that the
Americans would not accept the tea if the Townshend duty remained.[31] But North
did not want to give up the revenue from the Townshend tax, primarily because it
was used to pay the salaries of colonial officials; maintaining the right of taxing the
Americans was a secondary concern.[32] According to historian Benjamin Labaree,
"A stubborn Lord North had unwittingly hammered a nail in the coffin of the old
British Empire."[33]
Even with the Townshend duty in effect, the Tea Act would allow the East India
Company to sell tea more cheaply than before, undercutting the prices offered by
smugglers, but also undercutting colonial tea importers, who paid the tax and
received no refund. In 1772, legally imported Bohea, the most common variety of
tea, sold for about 3 shillings (3s) per pound.[34] After the Tea Act, colonial
consignees would be able to sell it for 2 shillings per pound (2s), just under the
smugglers' price of 2 shillings and 1 penny (2s 1d).[35] Realizing that the payment
of the Townshend duty was politically sensitive, the company hoped to conceal the
tax by making arrangements to have it paid either in London once the tea was
landed in the colonies, or have the consignees quietly pay the duties after the tea
was sold. This effort to hide the tax from the colonists was unsuccessful.

Resisting the Tea Act

This 1775 British cartoon, "A Society of Patriotic Ladies at Edenton in North
Carolina", satirizes the Edenton Tea Party, a group of women who organized a
boycott of English tea.
In September and October 1773, seven ships carrying East India Company tea were
sent to the colonies: four were bound for Boston, and one each for New York,
Philadelphia, and Charleston.[37] In the ships were more than 2,000 chests
containing nearly 600,000 pounds of tea.[38] Americans learned the details of the
Tea Act while the ships were en route, and opposition began to mount.[39] Whigs,
sometimes calling themselves Sons of Liberty, began a campaign to raise
awareness and to convince or compel the consignees to resign, in the same way
that stamp distributors had been forced to resign in the 1765 Stamp Act crisis.[
The protest movement that culminated with the Boston Tea Party was not a dispute
about high taxes. The price of legally imported tea was actually reduced by the Tea
Act of 1773. Protesters were instead concerned with a variety of other issues. The
familiar "no taxation without representation" argument, along with the question of
the extent of Parliament's authority in the colonies, remained prominent.[41]
Samuel Adams considered the British tea monopoly to be "equal to a tax" and to
raise the same representation issue whether or not a tax was applied to it.[42]
Some regarded the purpose of the tax programto make leading officials
independent of colonial influenceas a dangerous infringement of colonial rights.
[43] This was especially true in Massachusetts, the only colony where the
Townshend program had been fully implemented.
Colonial merchants, some of them smugglers, played a significant role in the
protests. Because the Tea Act made legally imported tea cheaper, it threatened to
put smugglers of Dutch tea out of business.[45] Legitimate tea importers who had
not been named as consignees by the East India Company were also threatened
with financial ruin by the Tea Act.[46] Another major concern for merchants was that
the Tea Act gave the East India Company a monopoly on the tea trade, and it was
feared that this government-created monopoly might be extended in the future to
include other goods.[47]
South of Boston, protesters successfully compelled the tea consignees to resign. In
Charleston, the consignees had been forced to resign by early December, and the
unclaimed tea was seized by customs officials.[48] There were mass protest
meetings in Philadelphia. Benjamin Rush urged his fellow countrymen to oppose the
landing of the tea, because the cargo contained "the seeds of slavery".[49] By early
December, the Philadelphia consignees had resigned and the tea ship returned to
England with its cargo following a confrontation with the ship's captain.[50] The tea
ship bound for New York City was delayed by bad weather; by the time it arrived,
the consignees had resigned, and the ship returned to England with the tea.