Tuesday, January 22, 2013

Taxation, Fairness and Ability-to-Pay Priciple

The notion of fairness and the ability to pay often coincide with the distribution of government finance. Equity is the art of distributing resources fairly and justly. Often, taxes conflict with people’s willingness to produce and invest. When there is too much government involvement in market activities, there could be general inefficiency. Monopolistic power influences the prices of products (Hyman, 2011). Modern industrialized nations have been able to implement fair economics through the equitable distribution of resources. On other hand, nondemocratic nations have not been able to advance in equity and efficiency because of the lack of administrative ease, unjust laws, and poor governance that put a cap on human progress. Efficiency entails raising revenues with minimal loss. When there is accountability and good bookkeeping and accounts, resources can be distributed efficiently and equitably. Thus, equity and efficiency can be achieved simultaneously. It is the responsibility of government to provide some of the most important goods and services we deserve. Through the benefits principle, people pay taxes in accordance with the benefits they receive from their governments.

Because of differing views in political and social economy, many prefer the ability-to-pay principle. In this principle, taxation is paid according to one’s financial ability. Two significant notions lead to equity: vertical equity which implies that people should pay taxes according to their means and the horizontal equity which implies taxpayers sharing same abilities should pay the same amount of taxation. Wealthy residences may receive better services than poor neighborhoods because they pay more for protective services. That is why we see heavy police presence in poor neighborhoods and less worries about crime and lawlessness in wealthy neighborhoods.

In American tax history, there have been divergent views on equity and efficiency among political leaders for years with little agreement from major political party leaders. Differing ideological foundations and self-interests are some of the factors that retard American tax reforms. The bailout of Fannie Mae contradicts the concept of equity and efficiency. Bailouts result in growing deficits to the nations’ economy (Stiglitz, 2008). After being elected president in 1980, tax reform became part of Ronald Reagan’s administration. Two tax laws were signed in 1981 and 1986 respectively during Reagan’s tenure of office. The term deregulation became a global concept during Reagan years (Fukuyama, 2008). Reagan believed that higher taxes undermined economic efficiency. Reagan saw the 50% marginal tax on the wealthiest as distorting economic incentives. However, Bill Clinton tilted the scale of balance by swinging the pendulum of political debate to a distinctly different direction.

Clinton, while running for office in 1992, felt that the rich were not paying their fair share of taxes. He felt that such existing unjust tax practices contravened his views on vertical equity. Clinton raised tax rates on the wealthy to 40%. A more sweeping reform emerged when George W. Bush ran for office (Gale & Orszag, 2004). Bush kept some of Reagan’s tax themes while reversing part of Clinton’s tax increases. Bush ended up reducing the highest tax rate to 35%. During George W. Bush’s tenure of office, his tax policies significantly conflicted with state tax policies and administration (Posner, 2007). According to Gale and Orszag (2004), Bush’s 2001 tax cuts were meant to “starve the beast”. In the 2008 presidential campaign, Senator John McCain proposed making Bush’s tax cuts permanent while Barack Obama recommended raising the top marginal tax rate. It is hard for the science of economics alone to determine the best way to level the objectives of equity and efficiency. The issue of efficiency and equity requires the collective involvement of economics and political philosophy.


Fukuyama, F. (2008). The fall of America, Inc. Retrieved from 


Gale, W.G. & Orszag, P.R. (2004). An economic assessment of tax policy in the Bush
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Gale, W.G. & Orszag, P.R. (2004). Bush Administration tax policy: Starving the Beast? Tax

            Notes. Retrieved from http://taxpolicycenter.org/UploadedPDF/1000705_Tax_Break_11-


Hyman, D.N (2011). Public finance: A contemporary application of theory to policy. Thousand

           Oaks, CA: Sage Publication, Inc.

Posner, P. (2007). The politics of coercive federalism in the Bush era. Publius, 37 (3), 390-412.

Stiglitz, J.E. (2008). Reversal of fortune. Vanity Fair. Retrieved from                 


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