Who Pays Taxes: The Nature and Economic Basis of Taxation

Many people use a very simple rule for evaluating taxes: the lower the taxes, the better. This view does not provide a helpful guide for designing a taxation system. Once the level of taxes to be paid has been chosen, the important question to be settled is the following: who pays taxes?

Experts try to answer this question by considering two aspects of taxation: efficiency and equity. Most people view an equitable tax system as being based on people’s ability to pay taxes. Although, some vehemently argue that taxes should instead be based on how much people benefit from public expenditure.

In considering the question of who pays taxes, two concepts need to be distinguished: vertical equity and horizontal equity. Vertical equity concerns equity across income groups. It focuses on comparisons between individuals or families with different levels of income. This concept is central to discussions of the progressive nature of taxation. Proponents of progressive taxation hinge their arguments on the following:

• Taxes should be based on the ability to pay.
• The greater one’s income, the greater the percentage of income that is available for goods and services beyond the bare necessities.
• The greater one’s income, the greater the proportion of income that is available to pay taxes.
• An ability to pay standard of vertical equity requires progressive taxation.

Horizontal equity concerns equity with a given income group. It is principally concerned with establishing just who should be considered equal to whom in their ability to pay taxes.

For example, two households with the same income may have different numbers of children to support. One of the households may have greater medical expenses, leaving less for both life’s pleasures and taxes. One of the households may have just lost its home in a fire. One of the households may incur greater expenses that are necessary for earning an income. All of these involve horizontal equity. There is simply no way to decide how much these and similar factors affect the ability to pay taxes.

Another factor in the equitable theory of taxation is the benefit principle. Here, taxes should be paid in proportion to the benefits that taxpayers derive from public expenditure. From this perspective, the ideal taxes are user charges, such as those that would be charged if private firms provided the government services.

In the absence of externalities, a tax normally does two things: it takes money away from the taxpayers and it changes their behavior. Taxpayers are typically made worse by both of these things. The revenue collected is called direct burden while the changed behavior is known as excess burden. When taxes do not cause changes in behavior, there is no excess burden and hence there is no economic inefficiency.

Who Shoulders Taxes?

On the question of who pays taxes, most of the taxes are shouldered by the top 1 percent of taxpayers, amassing a good third of all individual income taxes. This group has been shouldering this share for more than a decade now although their income has not grown proportionally to their tax share. On the other hand, the top 50 percent of income earners accounts for a whopping 95 percent share of people who pays income taxes in the U.S. Correspondingly, there is a decline on the share of income taxes paid by the bottom 50 percent.

For social security taxes, every person earning up to $102,000 annually pays security taxes and Medicare corresponding to 6.2 percent of the earner’s taxable income. The employer also contributes his corresponding 6.2 percent. For the self-employed, a whopping 15.3 percent is deducted from the taxable income as payment for social security taxes. So here, the query on who pays taxes is not much a question of who pays taxes in America, but rather more significantly a matter of who benefits from it.