1. The Economic Case for Fair
Taxation
Michael Krashinsky
Professor of Economics
University of Toronto

2. How do economists think about the issue of
equity – or fairness – in taxation?
Two fundamental principles:
3.Horizontal Equity
4.Vertical Equity
Horizontal equity requires that people with the
same ability to pay taxes in fact pay the same
taxes.
Vertical equity requires that people with more
ability to pay taxes pay more taxes.

3. Both principles depend on the idea of “ability to
pay.” But this is not a clear cut principle.
Should it be based only on income?
1. What about wealth? (eg. two individuals,
each with $100,000 in gross income, one has
no assets, one has $500,000 in bonds)
2. What about leisure? (eg. two individuals,
each earning $100,000 per year; one works 50
hours a week, the other 25 hours a week)

4. Should we tax only cash income, or should we
include imputed income? (eg. two
individuals, each earning $100,000, but one
owns a house and a vacation property)
Should we tax income or consumption?
And even if we decide to tax income, what about
credits or deductions? (eg. two individuals,
each earning $100,000, but one donates
$20,000 to charity) (what about religious
institutions?)

5. Carter said “A dollar is a dollar.” But that may
be a bit too simple. It presumes that we have
decided to tax income, and that we know what
to do about these other issues!
OK, let’s for a moment assume that we know
what to do about these issues. That takes care
of horizontal equity.
But what is constitutes vertical equity?

6. Vertical equity states that those with more
income should pay more tax, but how much
more tax? The economics here get very fuzzy!
Theory tells us that the value of each additional
dollar we earn diminishes. So if every person
paid the same absolute tax, it would be a much
smaller burden on the rich than on the poor.
So the rich should pay more, but how much
more?

7. Equal absolute sacrifice?
If a dollar is worth 5 times as much to a person
with an income of $20,000 as to a person with
an income of $200,000, then equal absolute
sacrifice requires the $200,000 earner to pay
5X as much
But as a fraction of well-being, equal absolute
sacrifice asks for a smaller fraction from the
wealthier person. Maybe more is required?
What about equal proportional sacrifice?

8. There is no easy economic answer to the
question of how much each group should pay.
Ultimately, this is a moral issue.

9. But we can ask the “easier” question. Has the
tax system become more or less fair in the last
couple of decades?
Here we do have an answer from economics:
The system is less equitable than it used to
be.
Study by Marc Lee (Canadian Centre for Policy
Alternatives – a somewhat left-leaning group)
“Eroding Tax Fairness” – easily available on-
line

10. Lee looks at all taxes paid by Canadians and
asks what is the tax rate as a percentage of
income in the various income deciles (lowest
10%, next 10%, etc.)
This mirrors earlier studies that looked at the
same issue – overall tax burden.
Basic conclusions:
The tax system is not as progressive as we think.
It has been getting worse, not better.

11. This worsening has taken place during a period
when the gap between the rich and the poor
has been widening, so changes in tax policy
have actually made things worse.
Table on next slide shows this:

12. Deciles Rate 1990 Rate 2005 Rate Change
Lowest 25.5% 30.7% +5.2%
D2 28.0% 31.0% +3.0%
D3 34.8% 31.8% −3.0%
D4 35.7% 33.3% −2.4%
D5 37.6% 35.4% −2.2%
D6 38.4% 36.5% −1.9%
D7 37.7% 36.4% −1.3%
D8 37.2% 35.7% −1.5%
D9 36.6% 34.9% −1.7%
Next 5% 38.6% 36.9% −1.7%
Next 4% 36.5% 33.8% −2.7%
Top 1% 34.2% 30.5% −3.7%

13. Two questions:
2.Why isn’t the tax system more progressive?
3.Why has it gotten worse?
5.Why isn’t it more progressive? I thought it
was progressive!
Federal income tax is progressive, but capital
gains. And sales taxes and property taxes are
regressive, as are payroll taxes (CPP, EI)

14. 2. Why has it gotten worse?
Phase out of federal surtaxes.
Bracket creep
Rises in payroll taxes
Rises in small gov’t charges