ABILITY TO PAY. A principle derived primarily from public finance theory which asserts that citizens should be taxed at varying levels or rates according to their respective economic strata. More generally, the ability to pay principle is a subset of the larger concept of equity, which states that people in equal situations should be taxed equally and people in unequal situations should be taxed unequally.
Professor Jones is opening her morning mail. The first item is a membership renewal notice for a professional association to which she belongs. She observes with some irritation that the association has introduced a new graduated dues schedule based on income. Students pay a flat rate of $30.00; members who earn $20,000-30,000 pay $60.00 in annual dues; those who earn $30,000-40,000 pay $80.00; and so on. As a result of the new graduated schedule, her dues to the association will increase by 35 percent over last year. She briefly considers canceling her membership or underreporting her income (lying). This is one of five associations to which she belongs and her total annual outlay for membership dues is nearly $500.00 and growing. Ultimately she decides to tell the truth and, somewhat grudgingly, writes a check to the association. She makes a mental note to reconsider her decision next year. Professor Jones has, at least temporarily and with some reluctance, accepted one of the operational notions of equity-the ability to pay principle.
The next item of mail is a subscription order for an academic journal. Professor Jones notes that the "institutional subscription rate" is $180.00, but the "individual rate" is only $65.00. She writes a check for the individual rate. Here, Professor Jones has readily and happily accepted another notion of equity-the benefit principle.
The last item in Professor Jones's mailbox is an announcement from the university administration regarding a new policy on photocopying. In an effort to save costs and discourage excessive photocopying, the university copy center will charge professors (or their academic units) differential rates based on consumption. Each academic year, the first 300 pages of photocopying for an individual professor will be charged at the rate of $0.04 per page; the next 300 pages will be charged at $0.05 per page; and so on up to a maximum of $0.09 per page, whereupon there will be a strong economic incentive to use the service of a private photocopying firm. Jones briefly reflects on the impact this policy will have on her, but quickly tosses the notice into the wastebasket, dismissing it as yet another example of bureaucratic micromanagement. Once again, Professor Jones has tacitly accepted a third notion of equity-the consumption principle.
These three illustrations are separate but related variants of the same underlying principle of equity-that people in equal circumstances should be treated equally ("horizontal equity") and that people in unequal circumstances should be treated unequally ("vertical equity").
The first example (graduated membership dues) is an example of the ability to pay principle in its purest and most elementary form. The assumption is that members of the professional association who have higher incomes can afford to pay higher dues. While most association members would not recognize it, there also is the implicit, and more controversial, objective of income redistribution among members of the association. Those at the low end of the income scale (such as students and young professionals) receive the full benefit of the association's services at a price that is arguably below fair market value. The more affluent members who pay dues that are well above fair market value are, in effect, subsidizing the membership of the less affluent. Note, however, that the dues schedule, as a proportion of income, remains constant at two-tenths of one percent of the high end of each income bracket (i.e., $60/30,000, $80/$40,000, and so on). This is a modified flat rate approach. It is not a perfect flat rate approach because income levels are divided into brackets. Thus, someone at the low end of the first income bracket ($20,000) pays the same amount ($60) as someone at the high end ($30,000). Consequently, lower-income members within each bracket pay a slightly higher proportion of their total income for membership in the association than higher income members within the bracket. A more sophisticated approach-the one upon which the U.S. personal income tax is based-would assume that people with higher incomes should not only pay more in absolute terms, but also should pay a higher proportion of their income relative to poorer people. The more sophisticated scheme is based on the theory of marginal utility of income which says that poorer people are, relatively speaking, more adversely affected by a flat tax than wealthier people even though they still pay far less than the wealthy in an absolute sense. Thus, a $500 tax for a person making only $5,000 is far more burdensome than a $ 10,000 tax for a person making $100,000 even though both persons pay exactly 10 percent of their income. Concerning the example of Professor Jones and the professional association, one could argue that a person making $30,000 is more adversely affected by a $60 dues payment than a person making $40,000 is by a $80 payment.