Marginal Tax Rate: What It Is, How To Calculate It, With Examples

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Marginal Tax Rate: What It Is, How To Calculate It, With Examples

What Is Marginal Tax Rate?

The marginal tax rate is the tax rate you pay on an additional dollar of income. In the United States, the federal marginal tax rate for individuals increases as income rises. This method of taxation, known as progressive taxation, aims to tax individuals based upon their earnings, with low-income earners being taxed at a lower rate than higher-income earners.

Key Takeaways

  • The marginal tax rate is the rate of taxation applied to the next dollar of income.
  • The marginal tax rate rises as income grows under the progressive income tax mechanism used for federal income tax in the United States.
  • The marginal tax rates are divided into seven tax groups based on income levels.

Understanding Marginal Tax Rate

Under a marginal tax rate, taxpayers are most often divided into tax brackets or ranges, which determine the rate applied to the taxable income of the tax filer. As income increases, the last dollar earned will be taxed at a higher rate than the first dollar earned. In other words, the first dollar earned will be taxed at the rate for the lowest tax bracket, the last dollar earned will be taxed at the rate of the highest bracket for that total income, and all the money in between is taxed at the rate for the range into which it falls.

Marginal tax rates can be changed by new tax laws. The current marginal tax rates went into effect in the United States as of Jan. 1, 2018, with the passage of the Tax Cuts and Jobs Act (TCJA) (TCJA).Under the previous law, the seven brackets were 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. The new plan, signed into law in Dec. 2017, keeps the seven bracket structure. However, adjustments were made to the tax rates and income levels. Under the TCJA, the new rates are 10%, 12%, 22%, 24%, 32%, 35%, and 37%.

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Marginal vs. Flat Tax

The other type of tax rate is the flat tax rate, which a few states implement for state income tax. Under this system of taxation, people aren’t taxed on a scale (like the marginal tax rate), but rather, flat across the board. In other words, everyone is charged the same rate, regardless of income level.

Most flat tax regimes do not allow for deductions and are seen in nations with a growing economy. Those who favor this taxation system characterize it as fair since it taxes all individuals and corporations at the same rate. Opponents argue that it results in high-income taxpayers paying less than they should for a more egalitarian society.

Marginal Tax Rate Example

In 2021, the rates and income levels for three sorts of filers are shown in the table below: single, married filing jointly, and heads of household.

RateFor Singles With Taxable Income OverFor Married Filing Jointly With Taxable Income OverFor Heads of Household With Taxable Income Over
10%$0$0$0
12%$9,950$19,900$14,200
22%$40,525$81,050$54,200
24%$86,375$172,750$86,350
32%$164,925$329,850$164,900
35%$209,425$418,850$209,400
37%$523,600$628,300$523,600

Individuals with the lowest income are put in the lowest marginal tax bracket, while those with greater incomes are placed in higher marginal tax rates. However, an individual’s marginal tax bracket does not dictate how much of their income is taxed. Income taxes are instead assessed gradually, with each bracket including a range of income values taxed at a certain rate.

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According to the present proposal, a single taxpayer earning $150,000 in taxable income would owe the following income taxes in 2021 (due in April 2022):

  • Bracket of 10%: ($9,950-$0) x 10% = $995.50
  • Bracket of 12%: ($40,525 – $9,950) x 12% = $3,669.00
  • Bracket of 22%: ($86,375 – $40,525) x 22% = $10,087.00
  • ($150,000 – $86,375) x 24% = $15,270.00 Bracket
  • 32% Bracket: Not applicable
  • 35% Bracket: Not applicable
  • 37% Bracket: Not applicable

When these sums are added together, the total tax due for this person is $30,021.50, representing an effective tax rate of 20.01% ($30,021.50 / $150,000).

Regardless of filing status, the seven marginal tax rates of the brackets stay unchanged. However, depending on whether the filer is a single individual, a married joint filer, or a head-of-household filer, the dollar ranges at which income is taxed at each rate vary. Furthermore, owing to a tax law feature known as indexing, the dollar range of each marginal tax band normally rises yearly to account for inflation.

What Is the Effective Tax Rate?

The effective tax rate is the percentage of an individual’s or corporation’s income that is paid in taxes. Individuals’ effective tax rate is the average rate at which their earned (such as wages) and unearned (such as stock dividends) income is taxed. A corporation’s effective tax rate is the average rate at which its pre-tax earnings are taxed, while the statutory tax rate is the legal percentage set by law.

What Is the Difference Between Effective and Marginal Tax Rate?

The effective tax rate, which is often lower, is a more realistic portrayal of a person’s or corporation’s entire tax burden than the marginal tax rate. Remember that when comparing a marginal versus an effective tax rate, the marginal tax rate refers to the highest tax band into which their income falls. In a progressive income-tax system, such as the one used in the United States, income is taxed at varying rates that climb when income exceeds specific thresholds. Individuals or businesses with income in the same highest marginal tax band may have drastically different effective tax rates depending on how much of their income is in the top bracket.

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What Is a Flat Tax?

A flat tax, also known as a regressive tax, imposes the same tax rate on all taxpayers, regardless of income level. A flat tax typically applies the same tax rate to all taxpayers with no deductions or exemptions permitted, however ideas to allow specific deductions are being examined. The majority of flat tax systems or plans exclude income from dividends, distributions, capital gains, or other assets from taxation.

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