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Equity, or economic equality, is the construct, concept or idea of fairness in economics and justice in the distribution of wealth, resources, and taxation within a society. Equity is closely tied to taxation policies, welfare economics, and the discussions of public finance, influencing how resources are allocated among different segments of the population.
According to Peter Corning, there are three distinct categories of substantive fairness (equality, equity, and reciprocity) that must be combined and balanced in order to achieve a truly fair society. [1] But while most of middle-income countries increased inequality in recent years, it is important to note that middle classes and—to a lesser extent—poorer-income groups seem to be getting an increasing share of income in recent years. To some, this advance is still vulnerable and needs to be quickly accelerated in the 21st century [2]
Equity in economics refers to a condition of fairness where the economic processes and their outcomes do not unduly favor or disadvantage any particular group or individual. This sense of fairness, or economic justice, attempts to balance economic disparities among different societal segments to promote a more inclusive and just society. Equity is a central issue in public sector economics and in public policy. It is at the heart of almost all economics policy debates, [3] which underscores the integral role that equity plays in shaping public decisions that impact overall societal welfare.
Equity looks at the distribution of capital, goods, and access to services throughout an economy and is often measured using tools such as the Gini index. Equity may be distinguished from economic efficiency in overall evaluation of social welfare. Although 'equity' has broader uses, it may be posed as a counterpart to economic inequality in yielding a "good" distribution of wealth. It has been studied in experimental economics as inequity aversion.
Defining equity presents inherent challenges due to its subjective nature, which depends heavily on societal values and individual perceptions of what is considered fair. Economists often struggle to establish a universally accepted definition of distributional equity because it involves making interpersonal comparisons of utility, which are inherently complex and controversial. Public finance in theory and practice highlights this difficulty: "Economists find it difficult to formulate an acceptable definition of distributional equity because it would require interpersonal comparisons of utility." [4] In practice, it may prove impossible to equalise choices without seriously impeding social objectives in other areas, such as the attainment of efficiency or the preservation of liberty. [5] This complexity is a significant barrier to forming a consensus on what constitutes equitable outcomes in economic policy.
The concept of horizontal equity means treating people alike if they are in the same or similar economic situations—making them pay the same taxes and/or providing them with the same public services. Implicit in the notion of horizontal equity is an assumption that people’s capacity to enjoy income is similar, at least within a given range of incomes. [6] This principle underpins many tax systems, advocating that those with comparable incomes should incur similar tax burdens. However, the practical implementation of horizontal equity is fraught with challenges, as defining what constitutes similar economic situations can be highly subjective and complex. Much of the complexity in the federal income tax arises from attempts to define equal economic situations for purposes of horizontal equity. [7]
A second and even more challenging concept of equity is vertical equity. Vertical equity means treating people differently according to the differences in their income, wealth, or other measure of need or ability to pay. [8] It is typically advocating that those who are better off should contribute more to the public coffers. This principle supports progressive taxation, where tax rates escalate with an individual's income or wealth. The rationale for vertical equity involves recognizing different capacities and needs among the population, which should influence their tax contributions. However, like horizontal equity, vertical equity also encounters practical difficulties. For example, one difficulty with using vertical equity as a guide to public policy is in measurement. Attempting to determine vertical equity also raises the serious problems discussed earlier that are associated with interpersonal comparisons of utility. [9]
Equity axioms are theoretical constructs that provide frameworks for understanding and implementing fairness in economic policies. While there are many variants of equity principles, they could be divided in two broad categories, namely, procedural and consequentialist. [10]
Among these, Hammond’s equity principle is notable. It suggests that a progressive transfer—redistributing income from richer to poorer individuals without altering their relative positions in terms of utility—enhances overall welfare. This principle is grounded in the belief that "an increase in one person's utility matched with a decrease in another person's utility that does not alter their respective positions on the utility scale – what we refer to as a Hammond progressive transfer – constitutes a welfare improvement.“ [11]
Another axiom is Sen's weak equity axiom, which states: „Let person i have a lower level of welfare than person j for each level of individual income. Then in distributing a given total of income among n individuals including i and j, the optimal solution must give i a higher level of income than j.“ [12] This axiom prioritizes the needs of the most disadvantaged when allocating resources, ensuring that equity considerations directly influence economic outcomes.
The role of equity in taxation is pivotal. An equitable tax system aims to distribute the financial burden fairly across different income groups, ensuring that everyone contributes their fair share towards public services. The principles of horizontal and vertical equity are often discussed regarding taxation.
In public finance, horizontal equity is the idea that people with a similar ability to pay taxes should pay the same or similar amounts. It is related to the concept of tax neutrality or the idea that the tax system should not discriminate between similar things or people, or unduly distort behavior. [13]
Vertical equity usually refers to the idea that people with a greater ability to pay taxes should pay more. If the rich pay more in proportion to their income, this is known as a proportional tax; if they pay an increasing proportion, this is termed a progressive tax , sometimes associated with redistribution of wealth. [14] Progressive tax is one of the main financial tools to help decrease the inequality between income groups.
In addition, Equity may also refer to inter-nation equity. As a theory, inter-nation equity is concerned with the allocation of national gain and loss in the international context and aims to ensure that each country receives an equitable share of tax revenues from cross-border transactions. The tax policy principle of inter-nation equity has been an important consideration in the debate on the division of taxing rights between source and residence countries. [15]
Equitability in fair division means every person's subjective valuation of their own share of some goods is the same. The surplus procedure (SP) achieves a more complex variant called proportional equitability. For more than two people, a division cannot always both be equitable and envy-free. [16]
A tax is a mandatory financial charge or levy imposed on a taxpayer by a governmental organization to support government spending and public expenditures collectively or to regulate and reduce negative externalities. Tax compliance refers to policy actions and individual behavior aimed at ensuring that taxpayers are paying the right amount of tax at the right time and securing the correct tax allowances and tax relief. The first known taxation occurred in Ancient Egypt around 3000–2800 BC. Taxes consist of direct or indirect taxes and may be paid in money or as labor equivalent.
In welfare economics, a Pareto improvement formalizes the idea of an outcome being "better in every possible way". A change is called a Pareto improvement if it leaves everyone in a society better-off. A situation is called Pareto efficient or Pareto optimal if all possible Pareto improvements have already been made; in other words, there are no longer any ways left to make one person better-off, without making some other person worse-off.
William Spencer Vickrey was a Canadian-American professor of economics and Nobel Laureate. He was a lifelong faculty member at Columbia University. A theorist who worked on public economics and mechanism design, Vickrey primarily discussed public policy problems. He originated the Vickrey auction, introduced the concept of congestion pricing in networks, formalized arguments for marginal cost pricing, and contributed to optimal income taxation. James Tobin described him as "an applied economist’s theorist, as well as a theorist’s applied economist.”
Public choice, or public choice theory, is "the use of economic tools to deal with traditional problems of political science." It includes the study of political behavior. In political science, it is the subset of positive political theory that studies self-interested agents and their interactions, which can be represented in a number of ways—using standard constrained utility maximization, game theory, or decision theory. It is the origin and intellectual foundation of contemporary work in political economy.
Public finance refers to the monetary resources available to governments and also to the study of finance within government and role of the government in the economy. As a subject of study, it is the branch of economics which assesses the government revenue and government expenditure of the public authorities and the adjustment of one or the other to achieve desirable effects and avoid undesirable ones. The purview of public finance is considered to be threefold, consisting of governmental effects on:
Welfare economics is a field of economics that applies microeconomic techniques to evaluate the overall well-being (welfare) of a society.
Sir James Alexander Mirrlees was a British economist and winner of the 1996 Nobel Memorial Prize in Economic Sciences. He was knighted in the 1997 Birthday Honours.
In economics, tax incidence or tax burden is the effect of a particular tax on the distribution of economic welfare. Economists distinguish between the entities who ultimately bear the tax burden and those on whom the tax is initially imposed. The tax burden measures the true economic effect of the tax, measured by the difference between real incomes or utilities before and after imposing the tax, and taking into account how the tax causes prices to change. For example, if a 10% tax is imposed on sellers of butter, but the market price rises 8% as a result, most of the tax burden is on buyers, not sellers. The concept of tax incidence was initially brought to economists' attention by the French Physiocrats, in particular François Quesnay, who argued that the incidence of all taxation falls ultimately on landowners and is at the expense of land rent. Tax incidence is said to "fall" upon the group that ultimately bears the burden of, or ultimately suffers a loss from, the tax. The key concept of tax incidence is that the tax incidence or tax burden does not depend on where the revenue is collected, but on the price elasticity of demand and price elasticity of supply. As a general policy matter, the tax incidence should not violate the principles of a desirable tax system, especially fairness and transparency. The concept of tax incidence is used in political science and sociology to analyze the level of resources extracted from each income social stratum in order to describe how the tax burden is distributed among social classes. That allows one to derive some inferences about the progressive nature of the tax system, according to principles of vertical equity.
Richard Abel Musgrave was an American economist of German heritage. His most cited work is The Theory of Public Finance (1959), described as "the first English-language treatise in the field," and "a major contribution to public finance thought."
Tax policy refers to the guidelines and principles established by a government for the imposition and collection of taxes. It encompasses both microeconomic and macroeconomic aspects, with the former focusing on issues of fairness and efficiency in tax collection, and the latter focusing on the overall quantity of taxes to be collected and its impact on economic activity. The tax framework of a country is considered a crucial instrument for influencing the country's economy.
In public finance, a sub-discipline of economics, fiscal incidence is the combined overall economic impact of both government taxation and expenditures on the real economic income of individuals.
Optimal tax theory or the theory of optimal taxation is the study of designing and implementing a tax that maximises a social welfare function subject to economic constraints. The social welfare function used is typically a function of individuals' utilities, most commonly some form of utilitarian function, so the tax system is chosen to maximise the aggregate of individual utilities. Tax revenue is required to fund the provision of public goods and other government services, as well as for redistribution from rich to poor individuals. However, most taxes distort individual behavior, because the activity that is taxed becomes relatively less desirable; for instance, taxes on labour income reduce the incentive to work. The optimization problem involves minimizing the distortions caused by taxation, while achieving desired levels of redistribution and revenue. Some taxes are thought to be less distorting, such as lump-sum taxes and Pigouvian taxes, where the market consumption of a good is inefficient, and a tax brings consumption closer to the efficient level.
Economic justice is a component of social justice and welfare economics. It is a set of moral and ethical principles for building economic institutions, where the ultimate goal is to create an opportunity for each person to establish a sufficient material foundation upon which to have a dignified, productive, and creative life.."
The Robin Hood effect is an economic occurrence where income is redistributed so that economic inequality is reduced. That is a redistribution of economic resources due to which the economically disadvantaged gain at the expense of the economically advantaged. The effect is named after English folkloric figure Robin Hood, said to have stolen from the rich to give to the poor.
Public economics(or economics of the public sector) is the study of government policy through the lens of economic efficiency and equity. Public economics builds on the theory of welfare economics and is ultimately used as a tool to improve social welfare. Welfare can be defined in terms of well-being, prosperity, and overall state of being.
Several theories of taxation exist in public economics. Governments at all levels need to raise revenue from a variety of sources to finance public-sector expenditures.
The benefit principle is a concept in the theory of taxation from public finance. It bases taxes to pay for public-goods expenditures on a politically-revealed willingness to pay for benefits received. The principle is sometimes likened to the function of prices in allocating private goods. In its use for assessing the efficiency of taxes and appraising fiscal policy, the benefit approach was initially developed by Knut Wicksell (1896) and Erik Lindahl (1919), two economists of the Stockholm School. Wicksell's near-unanimity formulation of the principle was premised on a just income distribution. The approach was extended in the work of Paul Samuelson, Richard Musgrave, and others. It has also been applied to such subjects as tax progressivity, corporation taxes, and taxes on property or wealth. The unanimity-rule aspect of Wicksell's approach in linking taxes and expenditures is cited as a point of departure for the study of constitutional economics in the work of James Buchanan.
Optimal capital income taxation is a subarea of optimal tax theory which studies the design of taxes on capital income such that a given economic criterion like utility is optimized.
The economics concept of a merit good, originated by Richard Musgrave, is a commodity which is judged that an individual or society should have on the basis of some concept of benefit, rather than ability and willingness to pay. The term is, perhaps, less often used presently than it was during the 1960s to 1980s but the concept still motivates many economic actions by governments. Examples include in-kind transfers such as the provision of food stamps to assist nutrition, the delivery of health services to improve quality of life and reduce morbidity, and subsidized housing and education.
This glossary of economics is a list of definitions of terms and concepts used in economics, its sub-disciplines, and related fields.