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Ability-to-Pay taxation is a theory that says Taxes should be levied based on the taxpayer’s ability-to-pay. People with higher Income should pay higher taxes, while those with lower income should be paying lower taxes. It should depend on their ability-to-pay.
One of the ideas behind the ability-to-pay principle is that those who have enjoyed much success and wealth in the society should be willing to give a little more to society. This is because they can do it also society has helped them achieve success.
Anil and Ajay are friends. Anil earns Rs. 15 lakhs per annum, whereas Ajay earns Rs. 6 lakhs per annum. Both of them pay their taxes. According to their tax bracket, both have to pay Rs. 1 lakh tax for the year 2020. Anil may not face an issue since he will be paying 1 lakh out of the 15 lakhs of his annual incomes, whereas Ajay will face a money crunch since he will have to pay Rs. 1 lakh out of the Rs. 6 lakhs he earns per annum.
The difference between both their income is huge. However, the tax levied is the same. The burden clearly falls on Ajay as compared to Anil.
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In 1776, Adam Smith, well-known as the father of Economics came up with this concept. This isn’t a recent theory based on progressive income tax.
Adam Smith wrote that the subjects of every state ought to contribute toward the support of the government, as near as possible, in proportion to their respective abilities; that is in proportion to the revenue which they respectively enjoy under the protection of the state.
Various advocates for this theory argue that every financially successful person in a society should be obligated to pay a little more than the others to keep the nation running. This is because of the various benefits they have received from society. This extra money can be used for infrastructure such as highways, public schools, free-Market system.
This will also mean that those who are contributing a little more will also enjoy the benefits of the same.
Critics argue that this is an unfair method. According to them it penalises hard work and success and reduces the incentives to generate more money. They argue that to make the system equitable, everyone should pay income-Tax Rate as a ‘Flat tax’.