What is Horizontal Equity?
Horizontal Equity is a tax treatment which states that a particular class of individuals who earns the same income should also pay the same amount of income tax. Under this system, suppose a person named Robert earns USD 45,000 annually and there is another person named Renata who also earns USD 45,000 in a financial year should pay an equal amount of tax in that financial year on their respective incomes. There should be no discrimination between the two in regards to their savings, expenditure, and deductions claimed but should be leviable with the same amount of income tax on their incomes.
Example of Horizontal Equity
Let us suppose there are 2 taxpayers X & Y, both earn USD 45000 during the period of their work in a company. Out of their earning, both X & Y make savings in their own ways, where X tends to save USD 15000 while Y can save USD 10000. After retirement, let us assume their return on investment is 10%. Determine how will the application of horizontal equity take place.
The application of horizontal equity would depend on how we consider the income of the individual, whether it is on an annual basis or a lifetime income basis. If we consider the income on an annual basis, then there will be horizontal equity application on both the taxpayer X & Y as they have the same income before their retirement and would be leviable at the same rate of tax until retirement. However, after retirement, their income would change as the investment made by both differ, i.e. Income of X would be USD 1500 (10% of 15,000 savings) and Income of Y would be USD 1000 (10% of 10,000 savings), and hence it would change after retirement period. Also, in the case of lifetime income, there would be no application of horizontal equityEquityEquity refers to investor’s ownership of a company representing the amount they would receive after liquidating assets and paying off the liabilities and debts. It is the difference between the assets and liabilities shown on a company's balance sheet. as the income over life would not be the same as both the taxpayers.
- All the taxpayers are treated equally.
- All the taxpayers have a real feeling of being treated fairly and equally.
- In the health sector, since everyone will be treated equally, therefore, there will be no bias in treating the patient. Patients with an emergency would be treated on priority rather than the ones with high income.
- Businesses are also not at a disadvantage as they feel that they are treated equally with other businesses and taxed at the same rate.
- There are many cases where the taxpayer may be paying a larger percentage but actually may pay less tax when all things are taken under consideration.
- Higher savings is discouraged as it does not lead to any tax exemption.
This has been a guide to what is Horizontal Equity and its definition. Here we discuss its example, measures, advantages, and disadvantages. You can learn more about accounting from following articles –