APPROACHES TO TAX EQUITY

HOW TO MEASURE ABILITY TO PAY

 SUBJECTIVE APPROACH- The sacrifice theory has
been evolved to measure ability to pay.
 OBJECTIVE APPROACH-The faculty theory has been
evolved to measure ability to pay.
 Implementation of either principle requires a
quantitative measure of ability to pay.
 Ability theory tries to measure the ability to pay with the
help of observable measures such as property ,
income ,sizes of family and consumption . These are
known as index of ability to pay.
 SUBJECTIVE APPROACH
 Estimate the burden felt by the taxpayer or the sacrifice
undergone by him
 Each taxpayer should make equal sacrifice, if tax burden is to be
justly distributed
EQUAL SACRIFICE PRINCIPLE
 The money burden of taxation should be distributed in such a
manner so that every taxpayer has to incur equal sacrifice
 All persons in a similar position should be treated similarly, so
that the horizontal equity is realised
 All persons in dissimilar position should be treated dissimilarly
in imposing taxes so that vertical equity, is also obtained
 FORMS OF EQUAL SACRIFICE PRINCIPLE
The theory of sacrifice to justice in taxation has
three aspects

 EQUAL ABSOLUTE SACRIFICE

 EQUAL PROPORTIONAL SACRIFICE
 EQUAL MARGINAL SACRIFICE
 EQUAL ABSOLUTE SACRIFICE
 Equal absolute principle implies that the loss of utility in parting with
income on account of tax should be equal to all taxpayers
 Thus, the persons with higher income should pay more than those
who have lower income in such a way that the sacrifice for each
individual is the same, provided that the marginal income utility
schedule has a declining trend
 It does not mean that it will lead to progressive taxation if the marginal
income utility schedule is declining
 Even a regressive tax, with declining income utility may satisfy the
Principle of Equal Absolute Sacrifice
 For e.g., an annual income of Rs.60,000 at 6 percent will pay Rs.3600
as tax, while an income of Rs.10,000 at 7 percent will pay Rs.700 as
tax. This may mean equal sacrifice for both
 But this leads to regressive kind of taxation
 Hence, most economists have strongly rejected this concept
 EQUAL PROPORTIONAL SACRIFICE
 It implies that the loss of utility, as a result of tax, should be
proportional to the total income of the tax payers
 Here too, an individual with higher income will pay more as a tax than
those who have lower incomes
 But the ratio of sacrifice to the income will be the same for all
taxpayers
 This can be expressed as
Sacrifice made by A Sacrifice made by B
_________________ = ____________________
Income of A Income of B
 Thus, the direct real burden on every taxpayer would be proportionate
to the economic welfare which he derives from the income
 A progressive tax structure is possible, as the marginal utility of
money diminishes with the rise in the income
 EQUAL MARGINAL SACRIFICE
 Taxes should be distributed in accordance with the principle of least
aggregate sacrifice, i.e., the marginal sacrifice imposed by way of
taxation on each taxpayer is equal
 The State should not touch the lower income group till the higher
incomes are brought to the level of lower incomes
 It implies that the taxation should first be imposed on an individual,
who has the highest income because he will make the least sacrifice
 When his income is reduced, by means of taxation to the level of
second richest person in the community, they should both begin to be
taxed because the sacrifice undergone in the payment of last rupee will
now be the same for both
 This process should continue till the required amount of revenue is
collected
 Equal marginal sacrifice requires what might be called maximum
progression, provided that the marginal income utility declines
Concepts of Nature of Tax Burden of Taxation
Sacrifice Structure Higher Lower
Income Group Income Group
1.Equal Less progressive Lowest Highest
Absolute
Sacrifice
2. Equal More progressive Higher Lower
Proportional than equal
Sacrifice absolute sacrifice
3.Equal Highly progressive Highest Lowest
Marginal taxation (with tax
Sacrifice exemption for low
income group)
 LIMITATIONS OF SUBJECTIVE APPROACH
 It is very difficult to equalise the marginal sacrifice of all the
taxpayers, because of the difference in tastes, temperament and
size of family
 Sacrifice being a subjective phenomena cannot be exactly
measured by a public authority; it can be realised only by the
person who makes a sacrifice.
 Income earned by means of personal service and hard labour
has great utility to an individual than income earned through
wealth and property. These facts have not been taken into account
in the subjective sacrifice approach to measure ability to pay.
 It is not possible to measure exactly the declining rate of
marginal utility as income increases. Hence, progression in the
rate of taxation is arbitrarily fixed and does not lead to
equalisation of marginal sacrifice for all.
 OBJECTIVE APPROACH
 Prof. Seligman has used the term ‘faculty’ to indicate
ability in the objective.
 Thus, it is also known as faculty theory of ability to
pay.
 The faculty theory takes into account the money value
of the taxable capacity of the taxpayer instead of his
feelings and sufferings.
 The faculty theory takes into account various external
factors including the tax-payer’s income and
property, etc., which actually influence the tax-paying
ability of an individual.
 INDEX OF ABILITY IN FACULTY THEORY
 There are three ways to measure ability to pay of a person
 INCOME: Income refers to an amount received by a family
from any activity during a certain period of time including the
value of self owned durable consumer goods. But only net
income should be taken into account.
 PROPERTY: The amount of property and accumulated wealth is
also considered, because the level of living of the people is not
only influenced by the income, but also by the accumulated
wealth and property.
 CONSUMPTION EXPENDITURE: Prof. Kaldor argued that
the economic well-being of the people depends upon the income
spent, i.e., upon the expenditure rather than upon the income.
Accumulated wealth and property cannot provide satisfaction
until it is used for consumption
 DEFECTS IN FACULTY THEORY
 A general property-tax is regressive, as it falls more heavily
upon smaller than upon larger property
 There is a lack of universality or failure to reach each personal
property
 It lacks in uniformity in assessment
 It may provide an incentive to dishonesty
 It is, thus, obvious that the objective approach plays a
supplementary role to the subjective approach in achieving the
objective of just distribution of the burden of taxation.
 Thus it is concluded that subjective approach to measure ability
to pay is not only a useful concept but an ideal one.
 In practical life, the scope of its application is very limited and
it is very difficult to achieve this ideal.