Vertical Equity: What It Is and How It Works

Definition

Vertical equity is the principle that taxpayers with greater ability to pay should contribute more in taxes. In practice, it means tax burdens rise as income rises, either through proportional or progressive tax structures.

How Vertical Equity Works

Vertical equity is grounded in the “ability-to-pay” concept: taxes should be tied to the taxpayer’s capacity to absorb the burden without undue hardship. Two common ways this is implemented:

• Proportional taxation (flat rate): everyone pays the same percentage of income. Dollar amounts paid increase with income, but the average tax rate is constant across incomes.
• Progressive taxation: tax rates increase at higher income levels through brackets or graduated rates, so higher earners pay a larger share of their income.

Example

Proportional example:
* Tax rate: 15% flat
* Earner A: $100,000 → pays $15,000
* Earner B: $50,000 → pays $7,500

Progressive example (conceptual):
* Lower portion of income taxed at lower rates, higher portions taxed at higher rates
* The effective average tax rate rises with income, so higher earners contribute a larger percentage of their income than lower earners.

Vertical Equity vs. Horizontal Equity

• Vertical equity: treats taxpayers differently according to ability to pay (higher incomes pay more).
• Horizontal equity: treats taxpayers with similar incomes and assets equally.

Horizontal equity is often harder to achieve because deductions, credits, and loopholes can lead similarly situated taxpayers to face different effective tax burdens.

Benefits and Limitations

Benefits:
* Targets tax burden according to ability to pay.
* Can reduce after-tax income inequality when progressivity is used.

Limitations:
* Determining “ability to pay” can be complex (wealth, consumption, liabilities).
* Progressivity can be influenced by exemptions, deductions, and tax avoidance strategies that weaken intended effects.
* Political and economic trade-offs exist between equity, efficiency, and growth.

Frequently Asked Questions

Q: Is vertical equity a method of income taxation?
A: Yes. It describes systems where taxes rise with income, implemented via proportional or progressive structures.

Q: What is vertical equity based on?
A: The ability-to-pay principle—taxes should reflect the taxpayer’s capacity to bear the burden.

Q: Is vertical equity easier to achieve than horizontal equity?
A: Often yes; horizontal equity can be undermined by special rules, deductions, and loopholes that make similarly situated taxpayers pay different amounts.

Conclusion

Vertical equity aims to align tax contributions with taxpayers’ ability to pay. Implemented through proportional or progressive tax systems, it ensures higher-income individuals contribute more in dollars—and, in progressive systems, a higher share of income—than lower-income individuals. Practical challenges include defining ability to pay and minimizing loopholes that erode fairness.