What Is the Ability-to-Pay Principle of Taxation?

Ability-to-pay is a philosophy in finance and accounting which suggests that taxation should be levied according to the taxpayer’s financial capability – the basic premise being those who make more can and should pay more in taxes.

Ability-to-pay definition

The ability-to-pay principle of taxation suggests that the amount of tax an individual or organization pays should be relative to the amount they earn, as a means of easing the financial burden that taxes can create for low-income households. This aligns with the concept of the progressive tax system.

Ability-to-pay taxes in the US

The US does employ a progressive, ability-to-pay tax system for federal income taxes, but many argue that the system still allows for and facilitates economic inequality.

Currently, tax codes in the US are divided into tiers based on annual income, with each tier taxed at a different rate. The tax amount for each tier is based on the theoretical amount that someone in that pay bracket should be able to pay. This system is designed to protect low-income earners, but it isn’t flawless.

In the 1980s, the highest income tax bracket for an individual was 70%. In the decades that have followed, this has shrunk down to a top rate of 37% for high earners. Today, the top 1% in the United States holds more wealth than the bottom 90%.

The ability-to-pay tax philosophy argues that those who earn the most have benefited the most from the system and should therefore be obligated to contribute more to keep the system going.

Below are the tax brackets for 2021 under the current progressive system:

<table> <tbody> <tr> <td> <p><strong>Tax Rate</strong></p> </td> <td> <p><strong>Single</strong></p> </td> <td> <p><strong>Head of Household</strong></p> </td> <td> <p><strong>Married (Filing Jointly) or Qualifying Widow</strong></p> </td> <td> <p><strong>Married (Filing Separately)</strong></p> </td> </tr> <tr> <td> <p><span style="font-weight: 400;">10%</span></p> </td> <td> <p><span style="font-weight: 400;">$0 to $9,950</span></p> </td> <td> <p><span style="font-weight: 400;">$0 to $14,200</span></p> </td> <td> <p><span style="font-weight: 400;">$0 to $19,900</span></p> </td> <td> <p><span style="font-weight: 400;">$0 to $9,950</span></p> </td> </tr> <tr> <td> <p><span style="font-weight: 400;">12%</span></p> </td> <td> <p><span style="font-weight: 400;">$9,951 to $40,525</span></p> </td> <td> <p><span style="font-weight: 400;">$14,201 to $54,200</span></p> </td> <td> <p><span style="font-weight: 400;">$19,901 to $81,050</span></p> </td> <td> <p><span style="font-weight: 400;">$9,951 to $40,525</span></p> </td> </tr> <tr> <td> <p><span style="font-weight: 400;">22%</span></p> </td> <td> <p><span style="font-weight: 400;">$40,526 to $86,375</span></p> </td> <td> <p><span style="font-weight: 400;">$54,201 to $86,350</span></p> </td> <td> <p><span style="font-weight: 400;">$81,051 to $172,750</span></p> </td> <td> <p><span style="font-weight: 400;">$40,526 to $86,375</span></p> </td> </tr> <tr> <td> <p><span style="font-weight: 400;">24%</span></p> </td> <td> <p><span style="font-weight: 400;">$86,376 to $164,925</span></p> </td> <td> <p><span style="font-weight: 400;">$86,351 to $164,900</span></p> </td> <td> <p><span style="font-weight: 400;">$172,751 to $329,850</span></p> </td> <td> <p><span style="font-weight: 400;">$86,376 to $164,925</span></p> </td> </tr> <tr> <td> <p><span style="font-weight: 400;">32%</span></p> </td> <td> <p><span style="font-weight: 400;">$164,926 to $209,425</span></p> </td> <td> <p><span style="font-weight: 400;">$164,901 to $209,400</span></p> </td> <td> <p><span style="font-weight: 400;">$329,851 to $418,850</span></p> </td> <td> <p><span style="font-weight: 400;">$164,926 to $209,425</span></p> </td> </tr> <tr> <td> <p><span style="font-weight: 400;">35%</span></p> </td> <td> <p><span style="font-weight: 400;">$209,426 to $523,600</span></p> </td> <td> <p><span style="font-weight: 400;">$209,401 to $523,600</span></p> </td> <td> <p><span style="font-weight: 400;">$418,851 to $628,300</span></p> </td> <td> <p><span style="font-weight: 400;">$209,426 to $314,150</span></p> </td> </tr> <tr> <td> <p><span style="font-weight: 400;">37%</span></p> </td> <td> <p><span style="font-weight: 400;">$523,600 or more</span></p> </td> <td> <p><span style="font-weight: 400;">$523,600 or more</span></p> </td> <td> <p><span style="font-weight: 400;">$628,300 or more</span></p> </td> <td> <p><span style="font-weight: 400;">$314,151 or more</span></p> </td> </tr> </tbody> </table>

Your tax rate isn’t necessarily how much you’ll end up having to pay – federal income tax uses a marginal rate wherein the last dollar earned is taxed at a higher rate than the first. If you earn between $9,951 and $40,525, you wouldn’t pay 12% of your entire earnings, for example. Instead, if your earnings exceed $9,950 as a single taxpayer but are less than $40,525, you’d pay 10% on the first $9,950 and 12% on the remainder.

If you earned $50,000 in the year, you’d pay 10% on the first $9,950, 12% on the next $30,574, and 22% on the remaining $9474, and so on.

These tax brackets show how those who earn more in the US are obliged to contribute more when it comes to taxes.

Criticisms of the ability-to-pay principle

On the other hand, some argue that such a system discourages economic success as it penalizes those who earn the most. The ability-to-pay principle is viewed by critics as a socialist ideal that hampers initiative and innovation in a free market economy.

The threat of significantly larger taxes disincentivizes hard work – if making more money means paying more taxes, making more money becomes unappealing – according to critics.

Instead, many would prefer a ‘flat tax’ or proportional tax system where everyone pays the same percentage in taxes.  

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