Horizontal Equity

A taxation theory based on equal worth and aims to protect taxpayers against arbitrary discrimination

What is Horizontal Equity?

Horizontal equity is a taxation concept that is used to determine the fairness of tax distribution. The theoretical underpinning of the horizontal equity is that taxes should be similar to all people in similar circumstances, regardless of the tax system in place. A tax system is considered to be equitable if it reflects the basic principle of equal worth.

 

Horizontal Equity

 

Horizontal equity can be compared with vertical equity, which calls for appropriate differentiation among the unequal. It is taken to mean that those who should contribute more taxes are in a position to pay more taxes.

 

Summary

  • Horizontal equity is a taxation theory based on equal worth and aims to protect taxpayers against arbitrary discrimination.
  • Taxpayers’ disposable income and lifetime income are the two commonly used metrics to group taxpayers in similar groups before imposing a specific tax limit.
  • A neutral tax system is considered a horizontally equitable tax system.

 

Understanding Horizontal Equity

The basic principle of horizontal equity is based on the concept of distributive justice, which posits that taxpayers should contribute to the same level of income tax in proportion to their respective income groups. It means that horizontal equity is premised on an impartial tax system.

Horizontal equity is logically viewed as equal treatment of equals in taxation so that equality is maintained before and after tax. Under the horizontal equity doctrine, some economists use income as the standard approach to group taxpayers as equals and impose proportional taxation as the fair means of distributing the tax burden. However, a taxpayer’s lifetime income is also considered by some economists as a better measure. The horizontal equity principle is attained depending on the type of income definition used.

 

Horizontal Equity vs. Vertical Equity

The concept of horizontal equity is used to gauge the fair distribution of tax burdens in line with the constitution’s fundamental principle of “equal protection under the law.” Under horizontal equity, individuals in similar situations are accorded the same tax treatment. For example, two individuals earning $25,000 each should contribute the same amount of tax. Therefore, horizontal equity maintains fairness and eliminates discrimination on grounds such as types of work or race.

Comparatively, the concept of vertical equity holds that different amounts of tax should be deducted from different income levels. In effect, it means that, as the disposable income increases, a taxpayer pays increased income tax. Vertical equity is in line with the principle benefit of tax, which requires that distribution of tax be in proportion to the benefits from the government.

Vertical equity differs from the ability-to-pay principle based on the fact that the former requires progressive tax based on income levels. Horizontal equity can be consistent with attaining vertical equity since the equal distribution of tax implies achieving vertically equitable distribution of tax burdens.

 

Application in Healthcare

Horizontal equity is also defined in the realm of health resource allocation. From such a perspective, health equity refers to the distribution of health resources based on the hierarchy of needs, rather than income differences or class privileges. The perspective arises from the fact that health services can hardly meet every individual’s needs. As with a non-discriminatory tax system, equity into health resources is divided into horizontal and vertical dimensions.

In vertical equity, social members with different levels of needs can receive different amounts of health resources appropriately. Conversely, horizontal equity refers to a situation where individuals with equal needs receive the same health resources. It acts as a measure of health resources allocation in the healthcare system by proposing that those who are equal in different capacities be granted equal healthcare.

 

Special Considerations

There are situations in which the equal treatment of equals in the taxation principle does not hold. A case in point is income generated from tax-exempt bonds. For example, consider Taxpayers A and B who are equal in all respects. Taxpayer A gets an interest of $9,000 from tax-exempt bonds, while B receives $9,000 as fully taxable interest. Take 30% as the tax rate for illustration, which gives $2,700.

The fact that both taxpayers report the same measured income, it might seem like horizontal equity. However, Taxpayer A owes no interest in the tax-exempt interest, while Yaxpayer B will contribute $2,100 on the interest income.

There are also cases where horizontal equity is not applicable – for example, in situations where taxes are levied to account for the external costs. With indifferent tax burdens for tobacco smokers and non-smokers, the standard horizontal equity provides limited applicability.

In such a case, tobacco taxes are intended to compel smokers to shoulder the external costs of smoking; hence, the apparent flouting of the horizontal equity principle is not considered problematic. The concept of horizontal equity is consistently used by policymakers to assess equal sharing of the tax burden in the tax system.

 

Related Readings

CFI offers the Certified Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

  • Ability-to-Pay Taxation
  • Negative Income Tax
  • Affordable Care Act (ACA)
  • Universal Basic Income (UBI)

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