When tax discussions arise, one of the most frequent topics involves fairness and equitable taxes. Horizontal equity is a principle that economists use to assess the fairness and equitability of taxes. The principle holds that similarly situated taxpayers pay the same amount in taxes. The interpretation of "similarly situated" is where much of the controversy arises.
In its basic interpretation, horizontal equity generally meets with little resistance. Horizontal equity appears to agree with the concept of equal worth and helps protect taxpayers against subjectively applied discriminatory tax practices. People in the United States use this principle to determine if the tax laws distribute the tax burden fairly -- typically across those in the same income bracket.
Different Income Sources
Because "similarly situated" is a broad term, some economists interpret horizontal equity to mean that taxpayers who have the same incomes should pay the same level of taxes. However, those with equal incomes may generate these incomes from different sources. One person may have earned income solely from employment while another may have earned income from employment but also have income from the sale of property or investments. In the United States the Internal Revenue Service taxes employment income as ordinary income and investment income as capital gains, the latter of which has a lower tax rate.
Agreeing on how to implement a horizontal equity-based tax system encounters additional problems. Equity or fairness relates to needs. However, those with the exact same income may not have the same needs and, therefore, may have different capacities to pay their taxes. One family may have five family members using its income; another may only have two. One family may have children with special needs or an ailing spouse and resulting high medical bills; another may have a family in perfect health.
The definition of family presents another problem in determining what similarly situated means. One group that lives together may not meet the traditional profile of a "family" and so the IRS calculates members' income separately instead of together. For example, the IRS and many states tax a married couple differently than they tax an unwed couple who live together. A multi-generational household with grandparents, parents and children is generally taxed differently than one with the same number that solely consists of parents and children.
In general the U.S. tax codes attempt to use horizontal equity as a barometer for fairness. Exemptions for self and dependents, deductions for mortgage interest and real estate taxes, specific tax credits for child care or certain income are all ways that the IRS utilizes the principle of horizontal equity. However, these provisions increase the complexity of federal and state taxes and sometimes cause others to question their fairness.
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