Somewhere in this country, someone is in very similar financial circumstances to yours. This includes the same household income, number of dependents and tax deductions. At tax time, your tax returns likely look very similar, and if the tax system is working as it should, your results are very similar, as well. This concept is known as “horizontal equity,” which states that two people making the same income with similar assets should pay the same dollar amount in taxes every year.
Horizontal equity is an economic concept in which two people of equal standing receive the same treatment.
The Definition of Horizontal Equity
Some economists believe it’s ideal to have a system based on horizontal equity, with taxpayers of equal earnings paying the same taxes regardless of their other circumstances. As a person’s income increases, so does his tax responsibility. Under current U.S. tax laws, for instance, a person making $50,000 a year pays 22 percent in taxes, while a person making $200,000 a year pays 32 percent. For those married filing jointly, the 22 percent bracket applies to a household income of $77,401 to $165,000.
The best thing about horizontal equity is that it prevents discrimination against people based on factors like race or gender. But one thing affecting America’s achievement of true “horizontal equity” status is all of the loopholes in the tax system. A corporation, for instance, can get tax benefits not achievable by a small business or individual taxpayer. For that reason, the U.S. tax system is considered a progressive one, which is a form of vertical equity where a person’s tax debt rises along with his income.
Tax Debt Differences
It may seem, on paper, that two people with the same income don’t pay the same in taxes, starting with the amount being held out of each paycheck. This is driven by the way withholdings are set up when you fill out Form W-4 at the start of a new job. The number of allowances you claim on that form will drive how much is taken out of each paycheck. If you claim more allowances, less will be held out of each paycheck, which may result in you owing money in April. At the same time, a co-worker with the same circumstances as you may have claimed fewer withholdings, resulting in a smaller paycheck but a big refund in April.
At tax time, there are other things that could make your own tax filing different from someone of the same circumstances. You may choose to do your taxes on your own and miss a few deductions that someone who uses a professional would catch. Or you may play it safer than someone who takes riskier deductions and may face an eventual IRS audit. This doesn’t mean the U.S. tax system isn’t set up for horizontal equity. It merely shows that multiple things can affect a person’s tax outcomes, regardless of the system tax collectors use.
Horizontal Versus Vertical Equity
Another concept when discussing equity is vertical equity, which is the idea that those who make more money should be taxed at a higher rate. There are several theories behind this idea, including that the wealthy can afford to pay the extra amount and that the wealth of the top income earners in America continues to rise while the lower and middle class remain mostly stagnant. Extra taxation would help level the playing field, some believe.
However, in a free economy, everyone benefits from those high-income earners. They keep the economy strong and unemployment rates low. But big businesses can also access experienced, high-dollar tax preparers who can advise them on ways to protect their income against taxation, and that’s a luxury lower earners can’t afford. It's important to note, though, that horizontal equity and vertical equity can operate within the same economic system, since those making more money being taxed at a higher rate, also known as vertical equity, are still within the same tax brackets as others of equal economic standing.
Measuring Horizontal Income
When measuring horizontal equity tax, there are two different theories. Some economists feel that horizontal equity applies specifically to the annual income a person is making in the present. But others take the approach that horizontal equity should be based on the lifetime earnings of a person. It can be more difficult to assess two people’s earnings during a snapshot of time, especially since incomes can differ so dramatically at the time someone retires.
The theory of looking at a lifetime earnings has to do with a person’s rate of consumption. If Taxpayer A and Taxpayer B earned the same income, but Taxpayer A saves while Taxpayer B spends, Taxpayer A will likely contribute more to the economy later in life than Taxpayer B, who will have to be thrifty due to not setting enough aside when she was earning a steady annual salary. By looking at Taxpayer A and Taxpayer B over the course of their entire lifetimes, some feel it’s easier to measure true horizontal equity.
Health Care and Horizontal Equity
Finances aren’t the only way to measure horizontal equity. It also applies to the health care services a person consumes. Horizontal equity states that two people should have the right to achieve the same level of health and well-being, which is measured at the point of care. The U.S. is set up on a health care system that relies heavily on businesses providing health care insurance to their employees. Some other developed areas of the world use universal health care, which takes care of a person’s health care costs whether they’re employed and regardless of socioeconomic status. However, horizontal equity is based mostly on health needs rather than finance, while vertical equity recognizes that those who have greater clinical needs should have more care.
Measuring horizontal or vertical equity in health care involves looking at how patients are charged, how long they’re required to wait, the quality of medical services they provide and access to care in the area in which they live. This can be challenging, though, since some people may not utilize the services that are available to them. There may also be cultural barriers to receiving care, such as not being fluent in the language nearby medical providers primarily speak.
Education and Horizontal Equity
Just as some call for horizontal equity in health care, they also believe it should apply to education. There have been measures over the years to ensure that every student in the U.S. gets the same education, regardless of where they live. But horizontal equity refers to equal treatment of equal students, which sets a standard that two students in the same area, of the same socioeconomic status, should receive an equal educational experience.
With vertical equity, though, proponents believe that everyone should receive the same education, regardless of where they live or what their cultural background is. In the classroom environment, teachers use a concept called differentiation to achieve this, which means they tailor their approaches to each student. If one student reads at a lower reading level than another student, for example, a teacher would offer individualized reading materials to help the slower reader come up to speed.
Procedural Equity and Equality
One area where a form of horizontal equity comes into play is in the workplace. Called procedural equity, this concept refers to the perception that employees should be paid equally for equal work. As with horizontal equity, procedural equity is designed to protect people against discrimination based on factors like race and gender. But procedural equity can be a difficult goal to achieve, even in a well-intentioned workplace. Workers often find that someone doing the same work is making at least slightly more, due in large part to the salary negotiating process.
The term “procedural equity” generally comes up when an employee files a complaint with HR citing unfairness in pay grading. For this reason, it can help businesses to regularly review employee pay and strive to come up with a way to ensure pay determination procedures would hold up during a legal audit. If one employee has skills that exceed another’s, for instance, this could be demonstrated in court and resolve any questions.
Understanding Intergenerational Equity
Another concept applied in finance is “intergenerational equity,” which refers to investments like pensions, where one generation puts in funds with the understanding that they’ll be able to access them later. The concept behind retirement funds, including Social Security, is that the people working today pay for the generations ahead of them, who retired after working for years to help pay out the retirement funds of those who had retired before them.
The problem with intergenerational equity is that it’s not an exact science. It relies on estimating what future generations will need. If too much is taken out, current generations transfer wealth to a future generation, while too little being taken out could transfer a burden to those who come after them. The theory in general, though, means different things to different people. Thomas Jefferson believed every generation should pay for the cost of its own retirement, not the cost of those who came before or after. On the other hand, Nobel Prize-winning economist Paul Samuelson believed pension benefits should not be prefunded.
Advantages of Horizontal Equity
The biggest advantage of horizontal equity is that all consumers are treated fairly. Horizontal equity means that two people of equal standing are treated the same. In a tax system with horizontal equity, everyone can feel as though they’re being treated fairly, with the same tax burden as those who are in the same situation as they are. Businesses feel as though they are not at a disadvantage since they’re being taxed similarly to other businesses of the same size, with the same annual income.
The advantage of horizontal equity in education is that school systems aren’t responsible for developing separate learning systems for various students. However, this can be at a cost to the students themselves. In health care, true horizontal equity means that all citizens can trust that they’ll get the health care they need, when they need it, rather than having to be at an economic advantage to get assistance during an emergency or health crisis.
Disadvantages of Horizontal Equity
One disadvantage of horizontal equity is that even in situations where two people are equal in one area, they generally are unequal in very important ways. This brings situations like “sin taxes,” where governments tax certain products higher than others. In some areas, taxes are higher on items like cigarettes, alcohol and even soda. States that don’t tax grocery purchases may also exclude some unhealthy items from their list of exemptions.
Where horizontal equity can break down, though, is that those who are economically advantaged will have the resources necessary to get the most out of whatever situation they’re in. This is especially seen in the tax system, where large corporations and wealthy individuals pay top accountants to come up with as many tax breaks as they can. This means that although they may be paying a slightly larger percentage, they actually may pay less in taxes when all things are taken into consideration.
Video of the Day
- Investopedia: Horizontal Equity
- Economics Help: Horizontal and Vertical Equity Definition
- Urban.org: Horizontal equity
- NIH: Essay 5Evaluating health-care equity
- Business Dictionary: procedural fairness Read more: http://www.businessdictionary.com/definition/procedural-fairness.html
- Terry Group: What is Intergenerational Equity?