Business, Legal & Accounting Glossary
Ability to pay is a borrower’s ability to meet certain financial demands, such as interest payments and principle, on long-term borrowings.
The principle that taxes should be levied on the basis of the taxpayer’s ability to pay. This normally leads to the view that as income or wealth increases; it’s marginal utility (it’s value to it’s owner) decreases, so that higher rates of tax may be levied on the higher slices. A typical progressive tax of this sort in the UK is Income Tax.
In taxation: The principle of ability to pay is that any tax should fall on those who afford to pay. In practice, taking account of ability to pay means that tax payments increase relative to the observed income or assets of taxpayers. In principle, however, earning capacity should also be taken into account.
The main objections to the ability to pay criterion is that earning capacity is un-observable, and that taxing income potentially acts as a disincentive towards work.
The collection of taxes from those who cannot afford to pay however, is unpopular, expensive and in some cases fundamentally impossible.
Ability to pay is an alternative to the benefit principle – which argues that only those who benefit from any given public expenditure should be taxed to pay for it.
The Government however, requires tax revenue to pay for public goods and the redistribution of income.
Given the level of revenue required to run a modern society, it may be inevitable that taxation processes transition further towards an ability to pay model in the future.
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This glossary post was last updated: 4th August, 2021 | 33 Views.