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Ability to pay refers to an individual’s cash flow to repay loans and the ability of high-income individuals to pay more taxes. It is important when lending money and is a redistributive concept in taxation. It has short-term benefits but may also have downsides.
Ability to pay is a financial term that relates to an individual’s cash flow to repay loans. Another commonly associated definition is the ability of high-income individuals to pay more taxes. Both concepts refer to cash flow situations for individuals and businesses. In the first scenario, banks and lenders assess the extent to which a borrower will be able to pay back the principal and related interest on a loan. This assessment and decision comes from the loan application process, in which banks and lenders review your credit history and cash flow. The latter focuses on income redistribution through government taxation.
Cash lending gives individuals and businesses the opportunity to purchase large or high-value dollar items when they do not have adequate cash flow. Individuals are constrained by personal income, while businesses are constrained by sales revenue and profit after business expenses. The ability to pay is important when lending money, as banks and lenders increase risk when lending money. If borrowers are unable to pay the balance, the financial institution will likely forfeit the loan to default and have to repossess the property rather than receive interest income from the loan.
Regarding taxation, ability to pay is a redistributive concept, where poorer or low-income individuals and families are spared heavy tax burdens. Ultimately, this results in high-income workers with a higher tax burden. In theory, this redistributes wealth, as wealthy individuals and families will have to part with their money by paying it to the government. Poor and low-income taxpayers will be able to hold their money, completing the redistribution cycle. These taxpayers may also receive credits, tax refunds, grants or other government-funded benefits through the ability to pay concepts.
Redistribution of wealth through taxation is usually found in nations or economies that favor socialism, although communist economies also have these characteristics. Socialist economies try to provide a sense of equality in lifestyle among citizens. Rather than having a small group of high-earning individuals or families in the economy controlling the economy, socialism tends to bring in poorer taxpayers through government programs.
Ability to pay has initial short-term benefits, as it allows low-income taxpayers to hold more cash. This will increase the consumption of this population and stimulate the process of producing goods and services in the local economy. However, there are also downsides to this concept. For example, taking money away from high-income taxpayers – who tend to be business owners and job producers – will be unable to support the economy in their collective business actions.
Asset Smart.
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