Horizontal Equity

Publication Date :

16 Nov, 2023

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Table Of Contents

What Is Horizontal Equity?

Horizontal Equity is a tax treatment that states that a particular class of individuals who earn the same income should also pay the same income tax. There should be no discrimination between the two regarding their savings, expenditure, and deductions claimed but should be leviable with the same amount of income tax on their incomes.

This theory can be applied to all individual taxpayers, who are considered to be earning a similar amount of money as income, even though the taxation process may be different. It aims to be impartial in the taxation process, promoting fairness and eliminating discrimination. However, the process is quite complex because it will require all such individuals to have similar objectives, personal attributes or access to same kind of benefits which is not easy to achieve.

What Is Horizontal Equity?

Horizontal Equity Explained

The concept of horizontal equity refers to the idea of implementing a situation where all people are treated in the same manner through imposition of same level of tax on their income provided they belong to an identical income group.

So in this process of horizontal equity in tax, individuals or corporates, who are the taxpayers, are not differentiated through the taxation system. The situation is tax neutral because it protects them in a way that ensures they have enough disposable income in their hands after the tax payment.

Under this system, suppose a person named Robert earns USD 45,000 annually, and 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.

It can be derived that the process demands a benchmark based on which the policymakers can decide the income levels and accordingly group them under the same taxpayer category. The annual income serves as such a benchmark or a measure to categorize them. Another yardstick is the lifetime income. The horizontal equity will depend on what kind of income is used fro measurement.

This concept is also applicable from the healthcare or horizontal equity in education point of view. Here, equality is based on the need of the individual in terms of healthcare facility or educational help and guidance. In case a group of people have the same requirement regarding healthcare facility or education, they will receive them at same level, which is also termed as horizontal equity.

It is to be noted that the concept excluded any tax incentives, credits, or any tax deduction that one might get, which usually brings down the tax payment and provides some relief to the taxpayer. It is an overall fair economic system, even though it is tough to implement.

Example

Let us understand the concept with the help of a suitable example.

Let us suppose there are two taxpayers, X & Y, who earn USD 45000 during their work in a company. Out of their earnings, both X & Y make savings in their 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 the application of horizontal equity will take place.

Solution:

The application of horizontal equity would depend on how we consider the individual's income, whether it is on an annual or a lifetime income basis. Let's consider the income on an annual basis. There will be horizontal equity application on taxpayers X & Y as they have the same income before retirement and would be eligible at the same tax rate 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 equity as the income over life would not be the same for both the taxpayers.

Advantages

Some noteworthy advantages of the concept are as follows:

All the taxpayers are treated equally.
All the taxpayers have a real feeling of being treated fairly and equally.
Since everyone will be treated equally in the health sector, 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 which is also the same as horizontal equity in education.
Businesses are also not at a disadvantage as they feel that they are treated equally with other businesses and taxed at the same rate.

Disadvantages

The disadvantages of the process are as given below.

There are many cases where the taxpayer may be paying a larger percentage but actually may pay less tax when all things are considered.
Higher savings is discouraged as it does not lead to any tax exemption.

Horizontal Equity Vs Vertical Equity

The above are two different principles of tax system that may be followed in any economy in order to provide equality to taxpayers and eliminate differenciation based on taxation. However, there are some differences between them as given below:

The main focus of the former is to eliminate differentiation among individuals who have similar economic situations or social circumstances and get same type of benefit, but the focus of the latter is to differentiate individuals based on their tax-paying ability and income earned.
The former promotes equality while the latter promotes the idea of progressive taxation.
The former follows the principle that people with the same economic background should be treated equally, irrespective of their characteristics. But the latter follows the principle that a high income earning individual should pay higher tax.

However, both of them have the objective of achieving fairness in the tax system either through the ability to pay or treating people under similar situations equally. But both aim to bring an economic balance through equitable treatment to its citizens even though both are complex concepts.