The ability to pay principle of taxation | Explain critically the principle of the ability to pay

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The principle of ability to pay or the ability to pay principle of taxation is associated with J.S Mill, Edgeworth and Pigou. According to this principle, an individual should pay tax according to his ability to pay. Taxes should be imposed on the basis of equity or justice and welfare consideration.

The ability to Pay Principle of Taxation

The ability to pay principle contain two approaches. They are-

(a) Subjective approach and (b) Objective approach

(a) Subjective Approach

According to the subjective approach equity principle is satisfied if all individuals make equal sacrifices. While contributing to common good.

Equal sacrifice means the sacrifice in terms of utility on income sacrificed by individual, due to payment of tax. In this approach there are different concepts.

(i) Equal Absolute Sacrifice – According to equal absolute sacrifice, each tax payer should make equal absolute sacrifice. It means the total disutility of a tax should be equal for the all tax payers. Let us suppose that there are two tax payers, ‘A’ and ‘B’. ‘A’ is a rich person and ‘B’ is a poor person.

According to equal absolute sacrifice principle we must get-

{U (Y) U (YT)}A  = {U (Y) U (YT)}B

Where, U(Y) = Income before Tax

U (YT) = Total utility of income after tax

U (Y) U (YT) = Total disutility of the tax payments.

(ii) Equal Proportional Sacrifice – According to this sacrifice principle, each tax payer should sacrifice the same proportion of total utility of satisfaction derived from his total income. It means that the sacrifice should be proportional to the total utility of income of the tax payer.

According to this principle-

{U (Y) – U (Y-T)/U (Y)A  = {U (Y) – U (Y-T)}/U(Y)B

(iii) Equal Marginal Sacrifice – According to equal marginal sacrifice, each tax payer should make equal marginal sacrifice. It means the burden of taxation should be so distributed that the direct real burden of all tax payer is equal.

This principle is also called “Least aggregate sacrifice principle”. According to Pigue, this principle is the ultimate principle of taxation. Mathematically it can be expressed as follows-

{du (Y-T)/d (Y-T)}A = {du (Y-T)/d (Y-T)}B

Here, du (Y-T) = Change in utility after Tax

d (Y-T) = Change in income after tax

Limitation of the subjective approach

The subjective approach suffers from following shortcomings-

• Sacrifice is subjective phenomenon and can not be measured directly.

• This principle is based on the law of diminishing marginal utility, but this law may not apply in all cases.

• Subjective approach is only an ideal principle which ignores the realities of practical life.

• The utility of income person are not identical.

• Subjective approach is not scientifically true.

(b) Objective Approach

According to objective approach, tax structure should be based on certain objective terms. There are generally three indices to measure the ability to pay principle of taxation. This theory is also known as “Faculty theory of ability to pay”.

(i) Income – Income is widely accepted as a true index of a person’s ability to pay. Under this index persons with higher incomes should share a large money burden of tax. Here only net income are to be taxed.

(ii) Property – According to this index, a person with properly has a better ability to pay a tax. Than a person having no or very little property. Thus taxation should be imposed on the basis of the extent of property owned by the people.

(iii) Consumption Expenditure – According to this index, a person spending larger amounts on consumption has greater ability to pay. Therefore, persons with a higher consumption expenditure should contribute a large share of the total tax amount.

In a developing economy, taxation on consumption expenditure promotes saving and investment and this has favourable effects on capital formation.

Criticism of the ability of pay principle of Taxation

The ability to pay principle is criticised on the following grounds-

• This principle is based on unrealistic assumption of utility measurement.

• The use of income as an index of ability to pay has serious limitation. The ability can not be justice on the basis of income.

• This theory is vague in the sense that it has three interpretation and one fails to know which of these interpretation is to be followed.

• The assumption of possibility of interpersonal utility is not valid.


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2 thoughts on “The ability to pay principle of taxation | Explain critically the principle of the ability to pay”

  1. This article was really helpful to know the concept of Ability to pay principle of taxation… Thank you


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