Ability-To-Pay Principle

Business, Legal & Accounting Glossary

Definition: Ability-To-Pay Principle

Ability-To-Pay Principle

Full Definition of Ability-To-Pay Principle

The ability-to-pay principle envisages that taxation should be levied according to an individual’s ability to pay; that is, individuals with higher incomes should be charged higher taxes.

Individuals with higher incomes are charged more taxes not because they use more government goods and services but because they have the ability to pay more. The primary indicator of ability to pay is commonly agreed to be income. Ability-to-pay principle is therefore in contrast with the benefit approach principle, which determines the amount of taxes a person should pay by the benefits received in public services. Ability-to-pay principle is based not on the benefits received but on the notion of equal sacrifice. It is considered to be characteristic of socialist sentiment, and is used in most industrialized economies; but equality of sacrifice is open to interpretation as it can be measured in absolute, proportional or marginal terms.

The main downside of the ability-to-pay principle is that it diminishes the incentive to work since a higher portion of the generated income will be collected by the government as taxes.

The ability-to-pay principle was extended by the Swiss philosopher Jean-Jacques Rousseau (1712-1778), the French political economist Jean-Baptiste Say (1767-1832) and the English economist John Stuart Mill (1806-1873).

The most popular variant of the ability-to-pay principle is called the equal marginal sacrifice principle.

Ability-To-Pay Principle FAQ's

What is the Ability to Pay Principle?

The ability to pay principle is the concept that individuals shouldn’t be required to pay taxes beyond their wherewithal to pay the taxes. In other words, it’s a concept that determines the proportional amount of tax levied on an individual based on his or her income and capability to afford the taxes.

This principle seeks to impose a higher tax on people with a higher income and a lower tax on people with a lower income, ceteris paribus. This way lower-income people aren’t taxed excessive amounts relative to their overall income.

This is the fundamental principle in the progressive tax system of the United States, which seeks income redistribution. The amount of money spent by wealthy consumers is higher than their basic necessities. Conversely, the amount of money spent by lower-income consumers is lower than their basic necessities. With this concept, the lower-income people can meet their tax obligations because they are lower than those of the higher-income people.

This concept also extends beyond simple tax brackets and income levels. For instance, individuals shouldn’t be taxed on transactions in which they don’t receive any cash. An example of this is stock options. An employee who is granted stock options receives something of value that is subject to taxation, but because they didn’t receive any cash, they can delay the tax on the options until they cash them in.

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Definition Sources

Definitions for Ability-To-Pay Principle are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 28th December, 2021 | 0 Views.