Question

Ricky and lucy are debating several types of taxes. their debate has focused on the differents types of tax rate structures and wheter thay are fair. Please define each tax rate structure, provide examples of each structure, and discuss how each structure may be viewed with respect to vertical equity

Answer 1

Definition of different tax structures and their examples and discussions are provided below:

Proportional tax rate structure – This is a flat tax rate structure in which a constant tax rate is imposed irrespective of the quantum of income being taxed. An example of such a type of tax rate structure is sales tax.

Progressive tax rate structure – In this structure an increasing marginal tax rate is being imposed with the increase in tax base. An example of progressive tax rate structure is federal income taxes.

Regressive tax rate structure – In this structure a decreasing marginal tax rate is being imposed with the increase in tax base. An example of regressive tax rate is state unemployment tax.

Vertical equity can be viewed on the basis of tax dollars paid or in terms of tax rates. Vertical equity is achieved when taxpayers who have a greater ability to pay taxes are actually paying more tax dollars. On this basis we can see that a proportional tax rate structure helps in achieving vertical equity as in the case of a proportional tax rate structure people with high income (and hence higher ability to pay taxes) will end up paying a higher absolute amount of taxes than people with low income.

Progressive tax rate structure is supported on the basis that taxpayers with a greater ability to pay should be subject to a higher tax rate. The relative burden of a flat tax rate declines as the income of a taxpayer increases. Here vertical equity is achieved only when taxpayers with a greater ability to pay are subject to a higher tax rate.

From the above discussions we can easily conclude that regressive tax rate structures does not satisfy vertical equity.