Net income provides a more accurate account of the financial status. Here’s why.
What is ability to pay?
Ability to pay is a principle of taxation. Individuals who earn more income pay more tax, not because they use more government goods and services, but because taxpayers who earn more have the ability to pay more. The progressive tax, or higher tax rates for people with higher incomes, is based on this principle.
American tax code breaks taxpayers into tiers based on their annual income, whether individual or combined for couples that are married and filing jointly. Each tier is taxed at a different rate, based on a predetermined amount of what someone earning an income within each tier should theoretically be able to pay.
This tax system is designed to protect lower income earners who cannot afford to pay as much in taxes as those who earn more money. Conversely, higher earners must pay a greater percentage of their income to balance the system.
Ability to pay is not the same as straight income brackets. Rather, it is a designation of whether an individual taxpayer can pay his or her entire tax burden or not.
Lower income earners often get a tax discount that prevents them from needing to pay the whole percentage amount that they owe on their taxes, while higher income earners generally pay the full percentage amount.
Ability to pay is also known as a progressive tax, because it taxes different payers along a sliding scale according to income. Progressive taxation is a cornerstone of income redistribution, since lower earners generally require more government assistance through taxpayer dollars, even though they contribute proportionally less.
Critics of the ability to pay system believe that the practice discourages economic success since it burdens wealthier individuals with a disproportionate amount of taxation. However, because of increasing federal debt and government budgetary requirements, other solutions often are deemed even more painful for taxpayers.
Ability to pay example
If you earn $30,000 a year, you fall into a tax bracket that is taxed at 15 percent, following the ability to pay principle. Thus, your annual taxes owed are $4,500.
Curious what you’ll owe next tax season? Use our tax calculator to estimate your future taxes.