marginal tax rate

Marginal vs Effective Tax Rates-What You Need to Know

marginal tax rate

Several readers have recently emailed me about Roth retirement accounts. The questions that have arisen include the difference between marginal tax rates and effective tax rates.

It’s an important topic that we’ll cover in two articles. In this article we’ll walk through the difference between marginal and effective tax rates.

In the next article we’ll cover how to use this information when evaluating Roth vs. pre-tax retirement contributions.

  • Marginal Tax Rate
  • Effective Tax Rate
  • Blended Tax Rates

Marginal Tax Rate

The marginal tax rate is the amount of tax paid on an additional dollar of income. Add one dollar of taxable income to your return, determine the amount of additional tax you’d pay, and divided that tax by the $1 of income. The result is your marginal tax rate.

Confused? Let’s review. The federal income tax system in the United States is progressive. As a result, not all of your taxable income is taxed at the same rate.

For 2014, for instance, if you’re a single taxpayer, your first $9,075 of income will be taxed at a 10% rate. What you make over $9,075 but under $36,900 gets taxed at 15%.

When you go over $36,900, the rate jumps to 25% up until you make $89,350. The rates continue to rise as you make more income. Currently for a single tax payer, those who make $406,750 per year are at the very top bracket.

Every dollar they make over that limit will be taxed at the highest rate – 39.6%.

It’s climbing stairs. The tax brackets are the steps. The more you make, the more steps you have to take. You can see the 2014 federal tax brackets for all filing statuses here.

When most people talk about marginal tax rates, they’re referring to the top tax bracket for their taxable income. For example, a person with taxable income for the year of $1,000,000 would have a marginal rate of 39.6%.

So would an individual with taxable income of $425,000. Why? The top bracket applies to all taxable income over the $406,750 for a single taxpayer. An individual with $100,000 in taxable income would fall into the 28% bracket.

Here’s the key. The marginal tax rate does not mean that the entire $100,000 of taxable income is taxed at the 28% rate.

The 28% marginal rate in this example is what one would pay on about the last $11,000 you make – the income that’s between $89,350 and $100,000.

Are hypothetical taxpayer would still paying 10% for the first $9,075 in taxable income, just every other taxpayer out there. And she would still pay 15% for income between $9,075 and $39,600, and so on and so forth.

Your marginal tax rate is only the rate that you pay on the last dollar of taxable income that you make.

Beyond Tax Brackets

So far we’ve focused entirely on the tax brackets. The marginal tax rate, however, can be a bit more complicated. Particularly for high income earners, various deductions and credits are phased out as more income is earned. In other words, the value of some deductions and credits are reduced as you make more money.

The purpose of phase outs is to focus the tax benefits on those who make less money. Phase outs are important in calculating your marginal tax rate. for example, if an extra dollar of taxable income reduces a deduction or credit, dish should be considered when determining your marginal rate.

As an example, the benefit of itemized deductions is phased out once taxpayers reach a certain taxable income level. Referred to as the Pease Limitation, after Congressman Donald Pease, this phaseout reduces the benefit of itemized deductions by 3% of each dollar earned over the phaseout limit. The net effect is to increase the marginal tax rates for the top three tax brackets by about 1%.

These phase outs are important. For example, when assessing the benefit of a pretax retirement contribution, your marginal tax rate should account for these phase outs. They have the effect of increasing the tax benefit of the retirement contribution, which can be an important consideration when evaluating whether to contribute to a pretax retirement account or a Roth retirement account.

Effective Tax Rate

The effective tax rate is easier to understand and calculate. It is simply the total income taxes an individual pays divided by their total income. The effective tax rate is generally much lower than an individual’s marginal tax rate.

The effective tax rate calculation serves several purposes. First, it can be helpful to compare your overall taxes from one year to the next. Second, it is useful in comparing overall tax liability between different individuals. This can be important when setting income tax policy.

Blended Tax Rates

Generally, marginal tax rates are used to make financial decisions. For example, one would look to his or her marginal rates in assessing the benefit of a charitable contribution.

wise, one generally looks to marginal rates in assessing whether to contribute to a pretax retirement account or a Roth retirement account.

In making these decisions, however, one must consider more than just the marginal tax rate.

For example, a $15,000 contribution to a pretax 401(k) may result in moving the taxpayer into a lower tax bracket. A single tax filer with approximately $94,000 in taxable income, has a marginal tax rate of 28%.

A $15,000 pretax retirement contribution, however, would move them into the 25% tax bracket. Approximately $5,000 of the contribution would save them 28% in federal income tax. The remaining $10,000 contribution would save them 25% in federal income tax.

The net effect is a tax savings that is a weighted average between the 28% and 25% tax brackets.

The move from one marginal tax rate to another, as well as the phase deductions and credits, complicates the choice between a pretax and Roth retirement account. On the bright side, it offers some potential for real tax savings. We’ll examine those potential tax savings in the next article in the series.

Источник: https://www.doughroller.net/taxes/marginal-vs-effective-tax-rates/

Marginal Tax Rate

marginal tax rate

Marginal tax rate is the rate at which an additional dollar of taxable income would be taxed. It is part of a progressive tax system, which applies different tax rates to different levels of income. As income rises, it is taxed at a higher rate (according to the bracket it falls in).

It’s important to note that income is not taxed at a single rate, but at multiple rates according to each tax bracket it falls in. Each tax rate only applies to income that falls within the corresponding bracket, and each additional dollar beyond that bracket would be taxed at the next highest marginal rate.

Examples of Marginal Tax Rate

Sarah is an accountant for XYZ firm and has a taxable income of $100,000 per year. Here’s how her income would be taxed using sample marginal tax rates:

Tax bracketMarginal Tax RateAmount taxableTax payable
$0-$20,0000%$20,000$0
$20,000-$40,00010%$20,000$2,000
$40,000-$60,00020%$20,000$4,000
$60,000-$80,00030%$20,000$6,000
$80,000-$100,00040%$20,000$8,000
$100,000+50%$0$0
Total$100,000$20,000

As you can see, Sarah’s income is taxed at different rates as it moves through the tax schedule, increasing as it enters each new bracket. Since any additional earnings would fall into the $100,000+ bracket, her marginal tax rate would be 50%.

How to Calculate Marginal Tax Rate

Marginal tax rate is calculated by multiplying the income in a given bracket by the adjacent tax rate.

When considering how marginal tax rate will affect an increase in income, you must first consider where in the bracket your current income lies. If your income will still remain in the same bracket after the increase, you’d simply multiply the increase by the corresponding tax rate. Here’s an example:

John’s taxable income is $50,000 per year, meaning his marginal tax rate is 20%. He gets a raise of $10,000, which brings his income to $60,000 per year. The additional income would be taxed at 20% because that income still falls within his current tax bracket. In this situation, his raise would be subject to: $10,000 x 0.20 = $2,000 in taxes.

Tax bracketTax Rate
$0-$20,0000%
$20,000-$40,00010%
$40,000-$60,00020%
$60,000-$80,00030%

If an increase in income would push your income into the next tax bracket, the increase would be subject to two tax rates; it would be taxed at your current marginal tax rate until it reaches the top end of your current bracket, and any amount that exceeds your current bracket would be taxed at the next highest rate. Here’s an example:

John’s income is $50,000 per year, meaning his marginal tax rate is 20%. John gets a raise of $15,000, bringing his income to $65,000 per year.

The first $10,000 of his raise would be taxed at 20% because it’s within his current bracket, but the next $5,000 would be taxed at 30% because it falls within the next bracket.

In this situation, his raise would be subject to: ($10,000 x 0.20 = $2,000) +  ($5,000 x 0.30 = $1,500) = $3,500 in taxes

Tax bracketTax Rate
$0-$20,0000%
$20,000-$40,00010%
$40,000-$60,00020%
$60,000-$80,00030%

Marginal Tax Rate Common Misconceptions

Filing your taxes can be a daunting task. Not only are there all sorts of terms and forms to be aware of, but there are also a variety of different tax rates that are easily confused. Here’s how marginal tax rate compares to other common tax rates:

Marginal vs. Effective Tax Rate

Un marginal tax rate – which is the highest rate that applies to your income – an effective tax rate is the overall percentage of your income that goes towards taxes. It’s calculated by dividing the total amount of tax payable by pre-tax income. 

Using the example above, Sarah’s effective tax rate would be:

In this situation, Sarah’s effective tax rate would be 20% (compared to her marginal tax rate of 50%). 

Marginal Tax Rate vs. Flat Tax Rate

A flat tax rate is exactly what it sounds : It’s a single tax rate that is applied to all incomes, regardless of the amount. Using Sarah’s $100,000 income example, a flat tax of 15% means that Sarah would owe $15,000 in taxes. 

It’s worth noting that some states utilize a flat income tax rate, such as Colorado, Illinois, Indiana, Massachusetts, Michigan, New Hampshire, Pennsylvania, and Tennessee.

2020 US Federal Income Tax Brackets

Marginal tax rates and brackets can change from year to year, the adjustments made by the Tax Cuts and Jobs Act in 2018. While rates and income brackets could be subject to change in the future, here are the 2020 US Federal Income Tax Brackets:

Tax rateSingle filerIncome aboveMarried individuals filing jointlyIncome aboveMarried individuals filing separatelyIncome aboveHead of householdIncome above
10%$0$0$0$0
12%$9,875$19,750$9,875$14,100
22%$40,125$80,250$40,125$53,700
24%$85,525$171,050$85,525$85,500
32%$163,300$326,600$163,300$163,300
35%$207,350$414,700$207,350$207,350
37%$518,400$622,050$311,026$518,400

Источник: https://investinganswers.com/dictionary/m/marginal-tax-rate

Marginal vs Effective Tax Rate | Top 8 Differences to Learn & Infographics

marginal tax rate

The confusion between marginal and effective tax is very common. This is because taxes are not necessarily paid tax on the entire income you earn but are paid after taking into account the different provisions. This is precisely the difference between marginal and effective tax rates.

Different countries follow different tax methods and there is also a difference in the tax brackets. Knowing the differences between these two rates is necessary for effective tax planning. The below table summarizes the difference between both these rates.

What is the Marginal Tax Rate?

The marginal tax rate can be defined as the tax paid on an additional dollar of income earned that is the rate that applies to the additional income earned.

The reason it is termed as “marginal” is that when your income moves up the tax bracket the marginal or additional income is taxed at the next highest tax bracket.

From tax payer’s perspective, the tax actually paid on the income differs from the marginal tax rate.

What is Effective Tax Rate?

The effective tax rate is the actual tax that is due your income and provisions. It is calculated as actual taxes divided by pre-tax income. The reason why marginal and effective tax rate differential is because of the difference between the income on the financial statements and total taxable income while calculating tax return.

Head to Head Comparison between Marginal vs Effective Tax Rate (Infographics)

Below are the top 8 differences between Marginal vs Effective Tax Rate

Key Differences between Marginal vs Effective Tax Rate

Let us discuss some of the major Difference Between Marginal vs Effective Tax Rate

  • The marginal tax rate is the percentage of income that will be paid on the next dollar of your income while the effective tax rate is the percentage of the total income that is paid on taxes.
  • The marginal tax rate can be defined as the tax paid on an additional dollar of income earned that is the rate that applies to the additional income earned. The effective tax rate is the total tax to be paid divided by the total taxable income.
  • Tax under marginal tax rate is calculated multiple tax rates making the computation complex and requiring additional compliance checks. Calculation under effective tax method is one rate which makes computation easier and there is no requirement of additional compliance checks.
  • Revenue collected by the government under the marginal tax system is higher than under the effective tax rate.
  • The marginal tax rate is lined with income and hence decreases when income decreases while under effective tax rate there is not much impact on the taxes when income decreases.
  • Higher-income attracts higher taxes under the marginal tax rate method and this discourages business expansion on the other hand higher-income attracts effective tax rates therefore, this method of tax calculation promotes business expansion.
  • Higher-income individuals or institutions pay more taxes under the marginal tax rate method while the tax burden under an effective tax rate mostly falls on the general group level.
  • Let us understand this by looking at a simple example and how these taxes will be calculated

Marginal Tax Rate

Let us consider an individual Mr. A who is a citizen of the USA and has a total income of $50,000 and let’s assume that will be taxed at 25%. So if Mr. A would get a raise next year and his income increases to $5800 next year the then $800 will be taxed at 25%.

Effective Tax Rate

Let us assume that Mr. A’s total tax is $5000 on his income of $50,000 his effective tax rate will be $50,000 / $5000 = 10%

Marginal vs Effective Tax Rate Comparison Table

Let’s discuss the top comparison between Marginal vs Effective Tax Rate:

Basis for ComparisonMarginal Tax RateEffective Tax Rate
Definition The marginal tax rate can be defined as the tax paid on an additional dollar of income earned that is the rate that applies to the additional income earnedThe effective tax rate is the total tax to be paid divided by the total taxable income
MeaningPercentage of income that will be paid on the next dollar of your incomePercentage of the total income that is paid on taxes
CalculationTax is calculated different tax ratesTax rate multiplied by the taxable income
Tax amountThe calculated tax amount is generally higher under this methodThe tax amount is lower as compared to the marginal tax rate
Tax impactHigher-income individuals or institutions pay more taxes under this methodTax, in this case, is diversified and is mostly paid by the general income group
DownsideWhen income decreases taxes also have an impact and goes down with decreasing incomeThere is not much impact on the taxes when income goes down
Economy Higher-income attracts higher taxes under this method and this discourages business expansionHigher-income attracts effective tax rates. Therefore, this method of tax calculation promotes business expansion
Complexity and ChecksMultiple tax rates for paying taxes makes this method complicated and checks and compliance are requiredNo checks are required since a single tac rate is involved which makes computation very easy

Conclusion

It is important to know the differences between marginal tax rate and the effective tax rate to make good tax decisions. You may have heard people say that their effective tax rate is ~30%.

This is actually higher than what they actually pay because they mainly focus on the marginal tax rate.

Many countries around the world follow the marginal tax rate regime since it is considered to be very logical as it taxes individuals or institutions income.

This has been a guide to Marginal vs Effective Tax Rate Here we have discussed the Marginal vs Effective Tax Rate key differences with infographics and comparison table. You can also go through our other suggested articles to learn more –

Источник: https://www.educba.com/marginal-vs-effective-tax-rate/

Marginal Tax Rate (Definition, Formula) | How to Calculate?

marginal tax rate

Marginal tax rate can be defined as a progressive tax structure where the tax liability of an individual increase with the increase in the amount of income earned during a financial year.

It simply means that as there is an increase in the income earned, there will be a corresponding increase in the tax rate that has to be paid. It aims to conduct a fair tax rate among the citizens on the basis of their individual income.

To explain it in simple words, the individuals that have an income that falls in the lower section will have to pay a lower tax rate on the taxable income whereas, an individual with a higher income will have to pay a higher tax rate on the taxable income.

Marginal Tax Rate U.S. Example

In the U.S., taxpayers are bifurcated into seven brackets on the basis of their taxable income – 10%, 12%, 22%, 24%, 32%, 35%, and 37%. Since the U.S. follows a progressive income tax pattern, as the income increases, so do the income tax. But this doesn’t mean that the people in the highest bracket pay the highest rate on all of their income.

The 7 income tax brackets and their bifurcations:

Marginal Tax Rate Formula

The mathematically driven marginal tax rate formula is as follows:

Marginal Tax Rate = ΔTax Payable/ ΔTaxable Income

Alternatively, the Marginal Tax Rate Formula is as follows:

Total Income Tax = Taxable Income(n) x Tax Rate under a Tax Bracket(m) + Taxable Income(n+1) x Tax Rate under a Tax Bracket(m+1)… So on

Example 1

Different countries have different rates pertaining to their income range, but the crux of the matter remains the same. If a person falls in a higher tax bracket, he will need to pay the tax rate applicable to all the lower brackets along with the tax bracket in which he falls in. The marginal tax rate calculation example below would give a better understanding.

The taxable income for John, a single resident of the U.S., is $82,000 for the year 2018-2019, the marginal tax rate for his income, according to the tax brackets mentioned above, will be 22%. If he were to earn an extra $501 of taxable income, he would be upgraded to the next tax bracket, which in this case, would be 32%.

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So, for $82,000 his tax would be:

Tax for income range $0-$9,525 @10%

Tax for income range $9,526-$38,700 @12%

  • = $38,700 – $9525
  • = $29,175 x 12%
  • = $3501

Tax for income range $38,701-$82,500 @22%

  • = $82,000 x 22%
  • = $18,040

Total tax = $952.50 + $3501 + $18,040

If John were to receive a bonus of say $15,000 by the end of the tax year his marginal tax would be 24%. In this case, he would need to make arrangements for deduction so that his taxable income is reduced and the pre-tax contributions are increased. Sounds confusing?

In simple words, he will need to look for alternative investment options life insurance cover, taking a car/home loan, or making charitable contributions that would eventually bring down his taxable income.

Example #2

Marc, an individual aged 28, earns $1,00,000 during the financial year 2018. Calculate Mark’s Income Tax liability if the following is the given taxation system in the U.S.

Will Marc be taxed at the highest rate of tax, i.e., 30%?

What is Marc’s effective tax rate?

Sol – No, Even if Marc has earned $10,00,000, his entire income will not be taxed at the highest tax rate but will be calculated as given below,

Therefore, the calculation of this formula will be as follows 

Marc’s effective tax rate= (Total Tax Payable/ Total Taxable Income)

= ($2,47,500/$10,00,000) x 100

Marc’s Effective Tax Rate will be –

  • Marc’s Effective Tax Rate = 24.75%

Example #3

Louis and Emma married assesses disclosed taxable income of $ 1,50,000 during F.Y. 2018. With the help of given below tax brackets, calculate the tax payable by them if they are filing a joint return as married filing jointly.

Sol – Since Louis and Emma opted for Married Filing Jointly, the tax will be calculated according to tax brackets given for this category and tax liability will be calculated as follows:

Total Tax Payable

  • Total Tax Payable = 24,879

Therefore, the calculation of this formula will be as follows

= Tax Payable/ Total Taxable Income

=($24,879/$1,50,000)

Marc’s Effective Tax Rate will be –

  • Marc’s Effective Tax Rate = 16.59%

Example #4

Calculate tax liability of Mr. Marc (unmarried) supporting more than half of family expenditure for full F.Y. 2018 having a total taxable income of $12,00,000 with the help of given tax brackets.

Sol. Since Mr. Marc is unmarried and is supporting more than half of his family expenditure, he is eligible to file an Income Tax return as head of household. Tax brackets applicable will be as follows:

Total Tax Payable

  • Total Tax Payable = 408,912.00

Therefore, the calculation of this formula will be as follows

=  Tax Payable/ Total Taxable Income

= ($4,08,912/$12,00,000) x100

Marc’s Effective Tax Rate will be –

  • Marc’s Effective Tax Rate = 34.08%

Advantages

  • The tax burden is shifted to the higher income group.
  • Protects the taxpayer; when income goes down, the tax will go down.
  • Governments earn more from Marginal tax.

Disadvantages

  • Discourages business expansion as higher-income would attract higher taxes.
  • It is unconstitutional as it does not treat the citizens of the same country equally.
  • The highest-earning citizens of the country may leave to avoid paying higher taxes.

What is Marginal Tax Rate and How Does it Work?

marginal tax rate

We hear a lot about tax rates. Often, what we pay in taxes is expressed as a percentage of income. However, it’s important to understand that the tax rate you pay doesn’t apply to your entire income. Instead, you will pay taxes a formula that looks at was is called the marginal tax rate.

What is Your Marginal Tax Rate?

Your marginal tax rate is the tax you pay on your last dollar of income. However, and more importantly for tax planning, your marginal tax rate is also what you’ll ly pay on your next dollar earned.

Since Canada operates on tax brackets, you will pay more tax when you earn more. However, it’s worth noting that you pay a rate the income in each bracket. So your marginal tax rate doesn’t reflect the total that you pay on your income. In fact, what you actually end up paying, in terms of a percentage of your income, is probably going to be lower than your marginal tax rate.

Even with the reality that your taxes will go up the more you earn, it’s possible to use the marginal tax rate to your advantage by planning ahead with RRSPs and other steps to reduce your taxes. Marginal tax rate should not be confused with your average tax rate, which is simply the amount of tax you pay divided by your income.

How Does Marginal Tax Rate Work?

To show how these tax rates work, I’m using the combined federal and Alberta rates for 2015. While your province may have different tax brackets and tax rates, Alberta has a flat provincial tax of 10%, and this will give you an idea of how marginal tax rates work. For the tax rates in your province, you can find all marginal tax rates at TaxTips.ca.

Technically the first tax bracket is $0 to $44,701, but I’ve included the effect on marginal tax rate from the federal basic personal amount of $11,327 and the Alberta basic personal amount of $18,214.

  • Up to $11,327 – tax rate of 0%
  • $11,327 to $18,214 – tax rate of 15%
  • $18,214 to $44,701 – tax rate of 25%
  • $44,701 to $89,401 – tax rate of 32%
  • $89,401 to $138,586 – tax rate of 36%
  • above $138,586 – tax rate of 39%

So if you lived in Alberta and made $44,000, your marginal tax rate would be 25%. But what if you were to get a $5,000 raise? Then you would be in the next tax bracket and paying 32% on that final $4,299. So, as you can see, you aren’t paying the entire 32% on all of your income.

You pay the percentage reflected in each bracket, so the first $11,327 isn’t taxed at all. That immediately brings down your effective tax rate. Additionally, as you can see, you only pay the 32% on any income that takes you above the threshold.

In this case, you are making $49,000 a year after your raise, but you aren’t paying 32% in taxes on that entire amount.

Knowing this is how you can best work towards reducing your taxes.

Investing in RRSPs Marginal Tax Rate

Sticking with the example above, it might make sense to put the $4,299 into an RRSP since you would get $1,376 back on your tax refund. However, putting any more into an RRSP that year may not be best since you would only get 25% back, not 32%.

While getting a 25% tax deduction might sound better than nothing, you need to look at what you expect to earn in retirement. Tax planning requires that you step back and look to the future. Now, if you have more money to save, this is where your TFSA can come in.

Make use of your RRSP within your highest tax bracket, but also look to use your TFSAs contribution room as well.

While you would be making $49,000 a year in this example, and will ly make more in future years, you would ly need less money in retirement.

With the house paid off, children moved out, and since you no longer need to put money money away for retirement, you may be able to withdraw less than $44,701 (or its equivalent whenever your retire).

This is when an RRSP works best, when you can get a a larger tax deduction from contributing and then pay a lower income tax in retirement. It’s important to understand this, since the money you withdraw from your RRSP is considered “regular” income.

Knowing and understanding Canadian tax rates, and how they work, is a key part of long-term financial and tax planning. Take the time to understand, and you will be able to get the most from your RRSP, now and in retirement.

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Источник: https://maplemoney.com/marginal-tax-rate-explained/

What Is the Marginal Tax Rate and What Are Progressive Taxes?

marginal tax rate

You may have heard about New York Congresswoman Alexandria Ocasio-Cortez talking about increasing the marginal tax rate on income above $10 million to 70%. You may wonder why someone would even bother making money if the government's going to take so much of it.

The government won't take 70%. That's not how the marginal tax rate works.

What Is the Marginal Tax Rate?

A marginal tax rate is the key concept behind progressive income taxes. It is defined as the amount of tax you pay on any given dollar of income.

People typically use the marginal tax rate to refer to the highest rate at which they pay income taxes. When someone says they have a 22% marginal rate, for example, they mean that this is the highest tax bracket for which their income qualifies.

In most cases people also think that this means they pay 22% of their income in taxes. This is wrong even though, unfortunately, some policymakers actively encourage this misconception. 

More accurately, the marginal tax rate is the percent taken from each given dollar of someone's income the tax brackets they qualify for. If someone says they pay a 22% marginal rate, for example, what that really means is some of their income qualifies for the 22% marginal rate, while other portions of their income qualify for the 10% and 12% marginal rates.

To understand this, we need to dive into progressive taxation and the notion of tax brackets.

What Are Progressive Taxes?

Progressive taxes are tax rates that escalate with income. This is as opposed to a flat tax, which taxes everyone at the same rate, and a regressive tax, which taxes earners more the less they earn. (The federal payroll tax is an example of regressive taxation, as low earners pay proportionally more than high earners.)

The purpose of progressive taxation is to raise sufficient amounts of government revenue while reducing the burden on low-wage earners. It is several observations, including:

  • A modern government requires far higher levels of revenue than the laissez-faire models of the 19th century. Funding this government requires collecting more money, typically from wealthier citizens and corporations who have more money to tax.
  • Confiscation matters more the less money someone earns. A low-income taxpayer can have their quality of life meaningfully changed even by comparably low rates of taxation while a high-income taxpayer will rarely change their standard of living due to taxes.
  • Higher top-end tax rates affect demand less than higher low-end tax rates. Consumers with relatively little money tend to spend each dollar that they get, while high-income consumers tend to spend up to a fixed amount and then save any additional money.

Critics of progressive taxation argue that it disincentivizes work by penalizing success.

Essentially, workers will tend to reduce their productivity if they know they'll get to keep less and less of any additional earnings.

While this is true at sufficiently high levels, there is no evidence that either current or historic U.S. tax rates have significantly reduced productivity (including the 70% top rate of the mid-20th century).

If anything, as noted above, the opposite is true. Low-end taxes reduce consumption on an almost dollar-for-dollar basis, while high-end taxes have had much less impact on work, investment or consumption. (It is important to note that high-income taxes can and do impact productivity at the right levels, but that effect has been minor within historic rates of U.S. taxation.)

To make a progressive tax system work, however, the government cannot charge a flat tax per income. Simply taking a third of someone's paycheck would result in exactly the sort of confiscatory taxes that critics warn about. Instead, progressive taxes rely on the concept of tax brackets.

What Are Tax Brackets?

Progressive taxation increases someone's taxes as they earn more money. But to try and make the system fair, and to prevent the tax seizures from meaningfully slowing down the economy, this system is split up into brackets.

A tax bracket is the percent that the government takes any given section of income. Each dollar of a new bracket is taxed at a higher rate than each dollar of the bracket below. Here, for example, are the tax brackets for a single person filing taxes in April, 2020:

  • $0 — $9,700: 10%
  • $9,701 — $39,475: 12%
  • $39,476 — $84,200: 22%
  • $84,201 — $160,725: 24%
  • $160,726 — $204,100: 32%
  • $204,101 — $510,300: 35%
  • $510,301 and more: 37%

The percent taken from each bracket is that section of income's marginal tax rate, and applies only to the income in that range. So to take an example, say Julie Smith made $100,000 in 2018 and is now filing her taxes as a single person. Her tax brackets would look this:

  • (9,700 — 0) x 10% = $9,700 x 10% = $970
  • (39,475 — 9,701) x 12% = $29,774 x 12% = $3,572.88
  • (84,200 — 39,476) x 22% = $44,724 x 22% = $9,839.28
  • (100,000 — 84,201) x 24% = $15,799 x 24% = $3,791.76
  • Zero dollars of income at 32% = Zero tax owed at this bracket
  • Zero dollars of income at 35% = Zero tax owed at this bracket
  • Zero dollars of income at 37% = Zero tax owed at this bracket

The way tax brackets work, Smith paid 10 cents in taxes on dollar No. 9,700 of her income. Then she paid 12 cents in taxes on dollar No. 9,701. The brackets are not cumulative, and as a result Smith's total tax liability is $18,173.92.

Notice that while Smith's top marginal tax rate is 24%, this only applies to a small percentage of her income. This is the purpose of the tax bracket system.

While individual taxpayers will move up through the brackets as they make more money, the IRS taxes all income at the same marginal rate.

Every taxpayer in America pays 10% on the first $9,700 of their taxable income, from a public school teacher making $33,000 to an Instagram millionaire.

The difference is that the Instagram millionaire will pay 37% on each dollar of income above $500,000, while the school teacher doesn't even earn enough money to achieve 22% taxation.

The Myth Of Bumping Up A Tax Bracket

A lot of myths and misunderstandings surround how tax brackets work, but the most persistent and pernicious is the idea that the marginal tax rate works a flat tax. People will talk about taking a loss because they got bumped up a bracket, and it's common to hear even professionals who should know better discuss how keeping your income below a bracket threshold can save you money.

This is not how tax brackets work.

Getting bumped up a tax bracket simply means that you have a segment of income which qualifies for a higher rate of taxation. However, as discussed above, all of your taxes below that bracket remain exactly the same. If you get a raise at work that pushes your income from $84,200 to $84,201 you will pay an additional $0.24 in tax that year and pocket $0.76 in extra income.

Absent complex issues of deductions and credits, it is not possible for someone to earn more money and suffer a net loss due to tax rates.

Applying the Marginal Tax Rate

The marginal tax rate is the percent taken from each portion of income you earn. So, all income between $84,201 and $160,725 has a marginal tax rate of 24%.

It is also used to describe the highest tax bracket that an individual falls into. Someone earning $100,000 can be described as paying a marginal tax rate of 24%. This is a slightly misleading characterization, however, because that person does not actually pay 24% of her income in taxes.

Marginal tax rates are key to understanding most of America's tax policy debates.

As politicians discuss raising and lowering taxes, it's essential to know that any given rate changes will not apply to an individual's total income.

When freshman Representative Ocasio-Cortez says that she would a 70% marginal tax rate on millionaires, what she means is that (for better or for worse) she would to take 70 cents each dollar earned in a year above the $1 million threshold.

Everyone in America pays the same marginal tax rates. The only thing that changes is which ones your income qualifies for.

Источник: https://www.thestreet.com/personal-finance/what-is-the-marginal-tax-rate-14882735

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