An analysis of the ability-to-pay principle of taxation

The ability-to-pay principle in plain words

Although taxation is a complex subject with terminology that can be hard to understand, when it comes to the ability-to-pay principle, it can be summarized in layman’s terms into the following phrase: “You can’t squeeze blood from a turnip”.

In Lucian’s Dialogues of the Dead, after bringing Menippus across, Charon (Death) asks the latter to give him his fare, and Menippus famously says to him: “I can’t, if I haven’t got it”.

If one attempted to translate the above simplified approach into the modern highly-sophisticated taxation systems that apply across the world, it would simply mean that low-income earners, who can otherwise be identified as those facing the risk of poverty (as it is stated on the Statistics Finland website), are de facto unable to pay taxes, just like Menippus, who was so destitute that he couldn’t even pay his fare to Death.

The connection between the ability to pay tax and a living wage

The starting point of the discussion on whether and how the ability to pay tax and the adoption of a living wage policy are connected is that a living wage policy should ensure a minimum standard of living for people and their families.

In fact, a person’s living wage is directly affected by their disposable income, which refers to income available after income tax has been deducted.

Therefore, disposable income is what is left over after income tax, and it can be spent by individuals, in order to achieve a good standard of living.

Further to that, if there any is amount left after meeting basic living costs, this amount is defined as discretionary income, which can be spent on meeting secondary needs, or saved.

As a result, it can be understood that, in addition to passing laws on minimum wage, in an effort to ensure a decent standard of living for citizens, governments should also make sure that they take the citizens’ ability to pay tax into serious account.

This is due to the fact that this ability is strongly interconnected with the idea of establishing a living wage, which is, in turn, interdependent on disposable income.

Taxes not affected by the ability to pay

In addition to income tax, there are other types of tax that individuals and consumers are asked to pay, such as sales tax, property tax, excise tax, and value added tax (VAT), to name a few.

As opposed to income tax, however, these taxes are neither calculated nor imposed according to an individual’s ability to pay.

They apply to all citizens, regardless of whether the latter earn a low or high income.

Therefore, unless there are any government subsidies or exemptions that apply to low-income citizens, when it comes, for example, to the amount of sales tax imposed on the sale of a specific good or service, this amount will be the same, irrespective of the income bracket that consumers belong.

However, since this amount will be the same, it will represent a different proportion of the income of low earners versus that of high earners.

In fact, low earners will have to pay a proportionally higher amount than higher earners, considering their lower income level.

As a result, it is generally argued that the income distribution effect of the ability-to-pay principle that applies to the taxation of income is reduced by the lower relevant buying power of low-income consumers, due to the opposite effect of universally applied taxes, which are imposed regardless of the personal level of income.

Therefore, the same product or service would cost relatively more to a low-income than a high-income earner.

Sources and further reading:

Ability to pay

Lucian, Dialogues of the dead, 1-20

Low income

What is a living wage? Definition, history, and how to calculate

Disposable and discretionary income

Seven ways Americans pay taxes

Sales tax

Ability-to-Pay Taxation: Definition and Examples