The Ability to Pay Theory

A progressive taxation system is a tax structure in which the average tax rate increases as an individual's income increases, meaning higher-income earners pay a larger percentage of their income in taxes compared to lower-income earners.

The Law of Diminishing Marginal Utility of Money states that as a person's income or wealth increases, the additional satisfaction (utility) they gain from each extra rupee decreases, meaning the first rupee earned brings more benefit than subsequent rupees.

The key principle of the Ability-to-Pay Theory of Taxation is that the burden of taxation should rise with the taxpayer's ability to pay, ensuring vertical equity in the tax system.

The Ability-to-Pay Principle suggests that higher-income individuals should be taxed more heavily, resulting in less total utility loss across society.

The philosophical basis of Equality of Sacrifice, articulated by John Stuart Mill, posits that the goal of taxation is fairness, achieved when all individuals make an equal sacrifice in terms of lost utility.

The Law of Diminishing Marginal Utility states that as income increases, the additional satisfaction (marginal utility) derived from each extra rupee decreases.

Richer individuals should pay more in taxes because they experience less utility loss per rupee compared to poorer individuals, leading to a fairer tax system.

Income reflects current command over resources; it is the most measurable and visible indicator.

Many assets, such as land and art, are illiquid and do not generate cash, which may force asset sales.

Consumption is regressive in practice because lower-income households spend a higher share of their income.

Equal Absolute Sacrifice (EAS) is a principle stating that everyone should lose the same total amount of utility from taxation, meaning that richer individuals should be taxed enough to experience the same utility loss as poorer individuals, resulting in moderate progressivity in taxation.

The formula for Equal Proportional Sacrifice (EPS) is [U(Y)-U(Y-T)] / U(Y) = K, which indicates that everyone should lose the same percentage of their total utility from taxation.

Equal Proportional Sacrifice (EPS) implies that everyone should lose the same percentage of their total utility, meaning if a poor person loses 20% of their utility, the rich should also lose 20%, which requires the rich to pay much more due to the Law of Diminishing Marginal Utility.

A tax system where the tax rate increases as the taxable amount increases, implying that wealthier individuals pay a higher percentage of their income in taxes compared to poorer individuals.

A principle stating that the marginal utility of income after tax should be the same for all taxpayers, ensuring that the utility of the last rupee left with each person is equal.

To equalize the pain per last rupee paid by taxpayers, ensuring that no taxpayer bears an unfair burden and that the last unit of money they hold provides the same satisfaction.

It results in the most progressive tax structure and minimizes total sacrifice in society, aligning with the Pigou-Dalton principle of Least Aggregate Sacrifice.

Because it aims to ensure that everyone is left with income that provides the same value from their last rupee, requiring wealthier individuals to contribute more to achieve equality.

Total utility loss

% of utility lost

Marginal utility after tax

The principle that taxpayers with similar income or economic ability should pay the same tax, ensuring fairness within income groups.

The principle that taxpayers with greater ability (higher income) should bear a larger tax burden, promoting redistribution and reducing income inequality.

It refers to the challenge that utility is subjective and personal, making it impossible to measure or compare utility across individuals accurately, which undermines the practical application of 'equal sacrifice' rules.

It describes the conflict where higher tax rates aimed at fairness may reduce incentives for individuals to work harder, save money, or invest in businesses, potentially leading to deadweight losses in the economy.

High progressive tax rates can lead to tax avoidance through legal loopholes and tax evasion through illegal hiding of income, resulting in increased compliance and enforcement costs for the government.

The Law of Diminishing Marginal Utility states that as a person consumes more units of a good or service, the additional satisfaction (utility) gained from each additional unit decreases. This principle supports progressive taxation to equalize the utility loss of taxation.

Equal Marginal Sacrifice is a theory in taxation that suggests that individuals should contribute to taxation in a way that equalizes the marginal sacrifice they experience. It provides the strongest justification for steep progressivity in tax systems.

The Ability-to-Pay Principle (ATP) remains the dominant normative theory in modern tax policy, despite limitations such as measurability, efficiency loss, and evasion.