Tax is a compulsory thing in every society. The government runs with the taxes. Public services are facilitated by taxes. There are different tax-paying systems that authorities use to collect tax. Horizontal equity and vertical equity are such systems. These systems are followed to keep the process fair and maintain equality.
Horizontal Equity vs Vertical Equity
The main difference between horizontal equity and vertical equity is that both are based on contrasting principles. The concept of equality is followed by horizontal equity. But in vertical equity, the ability of each taxpayer is taken into consideration to select their income bracket and finalize their tax.
There are various advantages to horizontal equity. The concept of equality is well maintained. It prevents any form of discrimination. But the loopholes in the tax system are a challenge in completely following the horizontal equity pattern. Two principles are used to measure horizontal equity; annual income and lifetime income.
The wealthy can afford to pay more is the basis of vertical equity. People who have more assets and income enjoy more benefits than low earners. Therefore, it is justifiable to increase their tax. But high earners have access to tax preparers to help them protect their income against taxation. Progressive, regressive, and proportional methods of taxation are applied in vertical equity.
Comparison Table Between Horizontal Equity and Vertical Equity
| Parameters of Comparison | Horizontal Equity | Vertical Equity |
| Definition | People in similar circumstances must pay identical taxes. | Tax increases with increase in income. |
| Principle | Equality | Ability to pay |
| Redistribution | Unequal, as wealthy people have more benefits | Equal |
| Example | Poll tax | Income tax |
| Tax measurement | Tax is measured according to income and assets. | Tax is determined according to the place in income brackets. |
What is Horizontal Equity?
Horizontal equity suggests that people with the same income levels must pay the same amount of taxes. It is based on equality. This is a socio-political concept rather than a financial concept. People in identical situations are treated the same way. It ensures that there are no biases based on caste, race, gender, or work.
For instance, if 3 people have 10000 dollars as income, they pay the same amount as tax, say 2000 dollars. There is no discrimination against taxpayers. Tax burdens are fairly distributed in this system. The tax is measured commonly according to the annual income. However, theorists believe that lifetime income must be considered as the measuring yardstick.
There are cases in which horizontal equity does not match the situation. Consider the example of tobacco tax burdens. A person who doesn’t use it doesn’t have to pay the tax. This is a violation in terms of horizontal equity. But the intention is not problematic.
This system is equitable as it is rooted in the principle of equal worth. Distributive justice is applied in this system, and this makes it impartial. It is also applied in healthcare. The health resources are distributed according to the needs and not based on the privileges. The disadvantages of this system include a lack of encouragement towards savings as there are no tax exemptions.
What is Vertical Equity?
This system is based on the ability to pay system. The tax amount increases with the rise in income. Those who can pay more should contribute in large amounts than those who don’t have such income. This ensures a fair distribution of tax among people.
Vertical equity involves progressive taxation. Hence, the rich pay more tax than the poor. This system is proportional to the total wealth created by an individual. Three kinds of equities are there in vertical equity: proportional taxation, progressive taxation, and regressive taxation.
In progressive taxation, the tax rate is determined by considering in which income bracket a person falls into. For example, a person who falls in the income bracket of $0 – $50000 should pay a 10% tax. While a person in the next bracket $50001 – $100000 must pay 20%. As the income increases, there is a tax increase.
Vertical equity is easier to apply as in most economies, there are tax benefits like deductions. Supporters of this system preach that wealthy people require more government services and thus they should pay more tax. Also, it is easier to establish this system of taxation in income-based taxation.
Main Differences Between Horizontal Equity and Vertical Equity
- In horizontal equity, the principle of equality in taxpaying is followed. While in vertical equity, the ability to pay principle is adopted.
- The tax benefits like tax deductions are still applicable in horizontal equity, which makes it unfair. But vertical equity applies easily in such benefits.
- Horizontal equity treats people in similar status as equals, and taxes are identical for them. Whereas vertical equity tax is measured according to the increase in income.
- Vertical equity enables equal redistribution of tax in society. Wealthy people must contribute more to public service. This is absent in horizontal equity as it is based on impartiality.
- A poll tax is an example of horizontal equity. In vertical equity income, brackets are taken into account while determining the tax. Income tax improves vertical equity.
Conclusion
There are various arguments based on horizontal equity and vertical equity. The benefit principle in vertical equity and the sense of equality in horizontal equity are both beneficial. It is hard to achieve these tax systems as there are various loopholes in both systems. So a combination of both can be used in an economy.
Those with higher earning capacity can provide more to the public service, and this tax is redistributed through social security benefits. People argue that this makes high potential earners hide their income or leave the country. Partly, strict taxation systems that follow vertical equity are not bliss for wealthy people. They are discouraged from increasing their wealth.
References
- https://www.journals.uchicago.edu/doi/abs/10.1086/NTJ41788830
- https://www.sciencedirect.com/science/article/pii/S0168851096008512