Horizontal vs. Vertical Equity in Taxation
Explore the core principles that define a fair tax system, examining the tension between treating equals equally and taxing based on ability to pay.
Tax systems are built on principles of fairness, known as equity. The two main concepts that guide tax policy are horizontal and vertical equity. These principles provide a framework for evaluating who pays and how much they pay, shaping the structure and impact of a tax code.
Understanding Horizontal Equity
Horizontal equity is the principle that taxpayers in similar financial situations should pay similar amounts of tax. It is often summarized as the “equal treatment of equals.” In its purest form, this means two individuals earning the exact same gross income and having identical financial profiles would have the same tax liability.
The application of horizontal equity becomes complex in practice due to tax deductions and credits. These provisions are designed to encourage specific behaviors or provide relief for certain expenses, but they can result in different tax outcomes for people with the same income. For example, consider two individuals who each earn $80,000. One person rents their home, while the other owns a home and can claim the mortgage interest deduction.
The homeowner can reduce their taxable income by the amount of interest paid, resulting in a lower tax bill than the renter, despite having the same initial income. Similarly, a person who makes significant charitable contributions can deduct those amounts, further reducing their tax liability compared to an identical earner who does not donate. These deductions, while serving other policy goals, create deviations from a purely horizontal system by treating taxpayers with equal incomes unequally based on their spending and lifestyle choices.
Understanding Vertical Equity
Vertical equity centers on the principle of “ability to pay,” which posits that individuals with greater financial resources should contribute a larger amount of tax. This concept addresses the fairness of the tax system across different income levels, asserting that those who can afford to pay more should bear a greater share of the tax burden. Unlike horizontal equity’s focus on treating equals the same, vertical equity is about the appropriate differentiation among unequals.
A progressive tax system is a direct application of vertical equity, where higher earners pay a larger percentage of their income in taxes. For instance, a person earning $50,000 might fall into a 12% tax bracket, while someone earning $500,000 faces a top marginal rate of 35% or 37%. This structure ensures that the tax burden, as a proportion of income, increases as income rises.
A proportional tax, often called a flat tax, requires all earners to pay the same percentage of their income. If the flat rate is 15%, an individual earning $50,000 would pay $7,500, and someone earning $200,000 would pay $30,000. While the absolute dollar amount is higher for the wealthier individual, the percentage of income paid remains constant across all levels.
Conversely, a regressive tax system is one where lower earners pay a larger percentage of their income in taxes. For example, a $1 tax on a gallon of gasoline represents a much larger portion of a low-income individual’s budget than that of a high-income individual, making the effective tax rate higher for the person with less ability to pay.
Application in Tax Systems
The principles of horizontal and vertical equity are often pursued simultaneously within a single tax system. The U.S. federal income tax is a primary example of a system designed to achieve vertical equity. It uses a progressive structure with multiple tax brackets, with rates for 2025 ranging from 10% to 37%, ensuring that as a person’s income rises, the rate applied to their highest dollars of earnings also increases. At the same time, it attempts to achieve horizontal equity by applying the same rules and calculations to all taxpayers, such as through the standard deduction, which for 2025 is $15,000 for single filers.
In contrast, a general sales tax is a clear example of a tax that strongly adheres to horizontal equity. Every consumer, regardless of their income, pays the same tax rate on a specific product at the point of sale. This ensures that two people buying the same item are treated identically by the tax system.
This strength in horizontal equity comes at the cost of vertical equity. Sales taxes are widely considered regressive because they consume a larger percentage of a lower-income individual’s earnings. A person earning $30,000 a year will spend a much higher proportion of their income on necessities subject to sales tax than someone earning $300,000. This dynamic shows how a tax can be fair by one measure while violating the core principle of the other.