Public Finance, 2nd Edition

lords would pay a tribute (tax) to the Crown in return for protection from

foreign enemies. Smith and Mill recognized the need for another principle of

tax equity for general taxes that were not so clearly tied to particular beneWts

received by the taxpayers.

The remainder of Chapter 11 focuses on the ability-to-pay principle,

indicating how to proceed from the principle to the design of broad-based

taxes. The U.S. federal personal income tax will serve as the primary applica-

tion throughout the chapter. Of all the broad-based taxes, it is the tax most

closely grounded in the ability-to-pay principle.

The Smith±Mill ability-to-pay principle and the Bergson±Samuelson

interpersonal equity conditions of Wrst-best theory are also compared and

contrasted. The older ability-to-pay principle would appear to bear a close

kinship to the newer interpersonal equity conditions. The taxes and transfers

implied by the interpersonal equity conditions surely depend on individuals'

economic well being, that is, on their ability to pay. Even so, the two

principles are not as closely related as one might think. They derive from

fundamentally diVerent views of taxation and, as such, they do not necessar-

ily imply that the government should collect the same tax revenues from

individuals or even use the same taxes.

ABILITY TO PAY: THEORETICAL CONSIDERATIONS

Smith and Mill recognized the limitations of the beneWts-received principle as

public expenditures became more varied and their beneWts more diVused

throughout the population. They reacted by introducing the concept of

taxes as a necessary evil, a sacriWce that individuals have to make for the

common good to support desired public expenditures. Given their perspec-

tive, they saw the fundamental question of tax equity as being one of how the

government should ask people to sacriWce for the commonweal, the common

good. Their answer was that people should be asked to sacriWce in accordance

with their ability to pay. In addition, the pattern of sacriWce should honor the

two principles of horizontal equity and vertical equity. Horizontal equity says

that equals should be treated equally. Two people judged to have equal

ability to pay should bear the same tax burden. Vertical equity allows for

the unequal treatment of unequals; that is, two people with unequal abilities

to pay can properly be asked to bear unequal tax burdens. This new Smith±

Mill ability-to-pay principle was a sacriWce principle, pure and simple. Tax-

payers should not expect a quid pro quo from general or broad-based taxes, in

direct contrast to taxes paid according to beneWts received.

1

Ability-to-pay

1

Adam Smith, The Wealth of Nations, E. Cannan, Ed., G. P. Putnam's Sons, New York,

1904, Vol. II, pp. 300±310. John Stuart Mill, Principles of Political Economy, W. J. Ashley Ed.,

Longmans, Green Co., Ltd., London, 1921, p. 804. For an excellent history of the development

of ability-to-pay principles, see R. A. Musgrave, The Theory of Public Finance, McGraw-Hill,

New York, 1959, chap. 5.

334 ABILITY TO PAY: THEORETICAL CONSIDERATIONS