Vertical equity is a taxation principle that states individuals and businesses should pay different tax rates depending on their level of income. It is based on the idea that individuals and companies should pay according to their ability to pay. In other words, those with greater economic power should pay higher rates of tax than those with lower economic power.

Vertical equity often manifests itself in the form of progressive taxation systems, which increase the percentage of taxes collected from taxpayers as their incomes increase. For example, a progressive tax system might levy a 10% tax on taxpayers making less than $30,000 annually and a 40% tax on those making more than $100,000.

In addition to progressive tax systems, vertical equity can also be achieved through the use of proportional taxation, which levies the same tax rate on all taxpayers regardless of income. Though it initially may seem counterintuitive, the advantages of proportional taxation are that taxation is straightforward and simple because everyone pays the same rate, deductions and loopholes are not allowed, and the system can be designed to ensure that everyone pays their fair share.

Under the principle of vertical equity, individuals and businesses should be treated differently in proportion to their ability to contribute through taxation. This means that those with higher incomes should pay a higher percentage of their income in taxes than those with lower incomes, in order to ensure that everyone pays their fair share. Vertical equity promotes fairness and helps to reduce income inequality. In the current US tax system, the majority of the US tax burden is shouldered by the wealthiest citizens since they are able to contribute more in taxes.

Some may argue that vertical equity can produce some of the adverse economic effects. A progressive tax system, for example, could lead to a decrease in the after-tax income of high-earning individuals and a decrease in their incentive to work, resulting in a smaller amount of tax revenue for the government. However, proponents of vertical equity argue that it will benefit the greater welfare of society.

Overall, vertical equity is an important principle of taxation and stands out as a major means of addressing income inequality. By using progressive tax rates or proportional taxation, vertical equity can be achieved, ensuring that everyone pays what they owe and providing an effective way of reducing the level of income inequality.