So the government needs to design a tax system that's going to be efficient, but that it's also going to be fair. Let's discuss tax equity in this video. Tax equity deals with the fairness of the tax system. It helps us answer these types of questions like how should the tax burden be divided? How do we judge if it's fair? So we're going to discuss 2 main principles when it comes to tax equity. The first one here being the benefits principle. The benefits principle says that people who receive the benefits, if you receive the benefits, you should pay the taxes. If you're going to receive the benefit, you should pay the tax. So there's a couple of examples here. The first one being a gasoline tax. This is a very common tax example for the benefits principle. So what's the benefit of the gasoline tax? They're going to put a tax on gasoline and then they're going to use that money to fix roads, right? They might use the tax revenue to fix potholes, right, maintain the roads in general and who's going to pay for it? Well, the people who use the roads. The people who drive are going to buy gasoline, maybe not if you have a Tesla, but in general, people who drive are going to pay for the gasoline and that money is going to be used to fix and maintain the roads. Another example here is a marina. So if there's a marina, a tax for using the marina, well, what's the benefit? Maybe they'll raise this tax revenue and they'll maintain the waterways, right? They'll maintain the waterways. It's common here in Miami for people who own boats and stuff like that; maybe I'll join them one day. So the marina tax, people who use the marina, who dock their boats at the marina, they're going to pay a tax and that money is going to be used to maintain the waterways, clean the ocean. So who's going to pay it? The people who use people with boats, right? People with boats who use the waterways, they're going to pay that tax. So this follows the benefits principle, right? Who is benefiting from the tax is paying the tax. Cool? Nothing too crazy there. Let's talk about the next one, the ability to pay principle. So this is that people who should pay taxes, they should pay taxes based on how easily they can afford it. In general, this means that if you have a lot of disposable income, well, you should have a little extra to pay more taxes. So poor people should not have to pay as much tax because it's going to be more of a burden to them. They're going to have to sacrifice more to pay some taxes here. So the idea about the ability to pay is that you should make an equal sacrifice to pay taxes. So let's look at these three different situations. The first person, they're making $10,000 and they have to pay $1,000 of tax. Right? This is a $1,000 tax on a 10,000 income. So we would say they're paying about 10% of their money in taxes. So what's their disposable income? This is the money they have left after they pay taxes. Well, that's going to be the 10,000 - 1,000. That leaves them with 9,000 in disposable income. Right? So notice they're still paying taxes, but they only have 9,000 left in disposable income. Now, what if someone with $50,000 only had to pay $1,000 of tax? So now a $1,000 of tax on 50,000, they're only paying 2% of their money in taxes. Right? So their disposable income, well, they have 50,000 and they only have to pay 1,000 in tax. They're left with 49,000 of disposable income. And we could say that they have a lot more disposable income here, right? That first 9,000 that the previous person had, well, they're probably going to have to spend that on rent, on food. Well, this person, if they spent the same amount, they'd still have another 40,000 left over. Now what about a $10,000 tax on 50,000 of income? So 10,000 on 50,000. Notice here they're paying 20% in taxes, but how much disposable income are they left with? They've got 50,000 minus the 10,000. They're still left with 40,000 in disposable income. Right? So even though they're paying a lot more taxes, they're paying 10,000 while the first person is only making 10,000, they still have a lot more disposable income. They still have a lot more luxuries they can afford even though they ended up paying more taxes. So what this does is it suggests that more taxes should be raised from people with higher incomes than lower incomes. This is what the ability to pay principle says because when you're not making a lot of money, it's a big sacrifice to pay a lot of taxes, right? Because you don't have a lot of money to begin with. When you have a lot of money, well, you can sacrifice a little more and it's not as big of a deal to you. This principle, the ability to pay principle, goes hand in hand with what we call vertical equity. The taxpayers with higher income pay more taxes, right? As you make more money, you should pay more taxes. This is vertical equity, right? You can afford more taxes because you're making more money. Now let's compare that to this other idea of horizontal equity. So this is the idea that people in the same economic situation should pay the same amount of taxes. Notice vertical equity, we're talking about equity going up and down the line of people making more money should pay more taxes because they can afford it. However, horizontal is people in the same situation should pay the same amount of taxes. So let's look at these 2 people. This is kind of an ethical question here. Look, the sick family so we've got the sick family. They're earning $100,000. They have no children and they pay $40,000 in medical expenses. While the school family, they also earn $100,000. They have 4 children and they pay $60,000 in tuition. So notice, it's very difficult to have horizontal equity here. Right? Because they're not in very similar situations but they're both burdened in similar ways. Right? They still while the sick family, their problem is that they have a lot of medical expenses, the school family, well, they have a lot of school expenses. Right? They have a lot of tuition expenses. So are they in the same economic situation? Not really. But how do we they're both still burdened quite a bit here. Right? So which one of them should receive a tax break? These are those ethical questions that come into play when we design a tax system, right? Should there be a tax break because they have a lot of medical expenses? Should there be a tax break because there are a lot of tuition expenses? These are the questions that need to be answered when designing a tax system and that's how we deal with the horizontal equity. Okay? So let's pause here and we'll discuss, the 3 types of taxes here, that we'll see in the next video. The regressive, proportional and progressive tax. Cool? Alright. Let's go ahead and do that in the next video.