Ability-to-Pay Principle of Taxation: Theory & Analysis

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  • 0:00 The Ability-To-Pay…
  • 0:38 Ability-To-Pay Theory…
  • 1:43 A Real-Life Example
  • 2:52 Analyzing The…
  • 3:12 Lesson Summary
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Lesson Transcript
Instructor: Tina Van Rikxoord

Tina holds a PhD in Accounting, a Master of Business in Information Security Management, and a Master of Arts in History

Governments impose taxes to pay for their operations and state services. But how do governments decide how to use a system of taxation to charge taxpayers for those services? One of the most common theories of how people should pay taxes is the ability-to-pay theory of taxation.

The Ability-to-Pay Theory of Taxation

The ability-to-pay theory is one of the main theories of taxation. According to the theory, taxes should be based upon the amount of money people earn. For example, those who earn more money are expected to pay a higher rate of taxes--which means a higher portion of their income--than people who earn less money. Remember, governments impose taxes to pay for services, like public schools, roads, police, and governance.

The ability-to-pay theory of taxation does not take into consideration the amount of these services that taxpayers actually use. For instance, all taxpayers contribute to public schools, even if they do not have any kids in a school system.

Ability-to-Pay System in the United States

In the United States, our government uses the ability-to-pay principle to impose a progressive tax system. In our system, all taxpayers fall within a particular tax bracket based upon their income and filing status. A tax bracket is a percentage rate imposed on a range of income. As you can see in Table One, as taxpayers' incomes increase, they fall into progressively higher tax brackets, or tax rates.

For example, in the 2014 tax year, single taxpayers earning less than $9,075 placed in the 10% tax bracket, meaning that they were expected to pay 10% of their earnings in taxes. Taxpayers earning between $9,075 and $36,900 were in the 15% bracket, while those earning $36,900 to $89,350 fell in to the 25% bracket, and so on. Note that most people actually pay less than the full amount of their tax bracket, due to tax credits and deductions. So someone in the 10% tax bracket may only pay 2% or 3% of their income in taxes.

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