What is the payment capacity?

Those with limited cash flow may struggle to pay.

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 relate to cash flow situations for individuals and companies. In the first scenario, banks and lenders assess how well a borrower will be able to repay the principal and interest on a loan. This assessment and decision comes from the loan application process, in which banks and lenders review credit history and cash flow. The latter focuses on income redistribution through government taxes.

Credit history is an indicator that determines a person’s ability to pay.

Lending money gives individuals and businesses the opportunity to purchase large or high dollar value items when they do not have adequate cash flow. Individuals are limited by personal income, while companies have restrictions related to sales revenue and profit after business expenses. Ability to pay is important when borrowing money, as banks and lenders increase risk when lending money. If borrowers are unable to pay the balance, the financial institution will likely lose the loan through default and will have to repossess the property instead of receiving the interest on the loan.

In relation to taxation, ability to pay is a redistributive concept, where the poorest or low-income individuals and families are spared heavy tax burdens. Ultimately, this results in high-income people bearing more tax burdens. 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 retain their money, completing the redistribution cycle. These taxpayers may also receive credits, tax refunds, subsidies, or other government-funded benefits through the ability to pay concepts.

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The redistribution of wealth through taxation is typically found in nations or economies that favor socialism, although communist economies also have these characteristics. Socialist economies try to provide a sense of lifestyle equality among citizens. Rather than having a small group of high-income individuals or families in the economy controlling the economy, socialism tends to bring in the poorest taxpayers through government programs.

The ability to pay has short-term upfront benefits as it allows low-income taxpayers to keep more money. This will increase the consumption of this demographic group and stimulate the process of producing goods and services in the local economy. However, there are also disadvantages to this concept. For example, taking money from high-income taxpayers – who tend to be business owners and job producers – will not be able to sustain the economy with their collective business actions.

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