Question

Describe how the concept of tax equity applies to income, payroll, and wealth-based taxes vs. transaction-based taxes

Answer 1

Taxation is a system that governments use to collect taxes from people and businesses, based on their income, assets, or transaction values. The primary purpose of taxation is to raise revenue for the government, although the government does use taxes to promote beneficial activities, such as starting a business or getting an education, or to limit undesirable behavior, such as smoking and drinking alcoholic beverages.

Taxation equity is the principle that taxes should be fair. However, there are several criteria for determining what is fair. The benefits principle states that people should pay taxes based on the benefits that they receive from government services. For instance, excise taxes on gasoline are used to build roads and bridges. However, taxes on income and investments are based on the ability to pay.

The ability-to-pay principle can be classified as vertical equity and horizontal equity. Vertical equity is the principle that people with higher incomes should pay more taxes, such as the provision for the increasing marginal tax rates on higher income. Horizontal equity is the principle that people with higher necessary expenses should pay less tax than someone else with equal income but without the expenses. A common application of this principle is the provision for the numerous deductions and tax credits available for people who have children, allowing them to pay less tax for a given level of income.

Another general principle that would make taxation more equitable is to consider the marginal utility of money. As with everything else, the marginal utility of money declines with increasing amounts. Each successive dollar of income holds less value than the previous dollar for the holder. This is because when people have less money, they need to spend it on essential goods and services, such as food, clothing, and health insurance