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# Marginal Tax Rate

Hard work is key to success in our lives, but it's important to consider the returns for working extra. No, this isn't a call for the made-up quiet quitting movement. Businesses calculate their return on investment for every action; as workers, it's also important for you. Would you double your hours working for a company if you knew that the additional income would be charged at a higher tax rate? That's where calculating and understanding marginal tax rates can help you get the most out of life. Read on to find out more!

## Marginal tax rate definition

The definition of a marginal tax rate is the change in taxes for earning one more dollar than the current taxable income. The term marginal in economics refers to the change that occurs with an additional unit. In this case, it's money or dollars.

This occurs on variable taxes rates, which can be progressive or regressive. A progressive tax rate increases as the tax base increases. A regressive tax rate decreases as the tax base increases. With a marginal tax rate, the tax rate usually changes at specific points. When not at those points, the marginal tax rate will likely be the same.

The marginal tax rate is the change in taxes for earning $1 more than the current taxable income. Marginal tax rates are important to understand because they can diminish the value of additional work or opportunities. Calculating how differing tax rates will affect the outcome is an important step in determining whether it's worth taking. Imagine a scenario where: Income under$49,999 is taxed at 10%.Income above $50,000 is taxed at 50%Let's say you work hard at your job and earn$49,999, keeping 90 cents per dollar you make. What is the marginal tax rate if you worked extra to make $1 more? After$50,000, you will only keep 50 cents per extra dollar you make. How much extra work are you willing to work when you keep only 50 cents, which is 40 cents less per dollar?

When it comes to tax, it's important to understand what effect taxes can have on a market system. Any increase in taxes will disincentivize work, as it is less profitable. Additionally, the taxes will take away funds from businesses that will grow their productive output. So, why would we continue a system where taxes exist if that's the case? Well, one of the theories behind government and taxation is that the utility provided to society as a whole is greater than the personal utility lost from the tax.

## Marginal tax rate economics

The best way to understand the economics of a marginal tax rate is to view a real-world example of them! Below in Table 1 are the 2022 tax brackets for filing classification "single." The US Tax system uses a marginal tax rate that divides your income by brackets. This means that the first $10,275 you make will be taxed at 10%, and the next dollar you make will be charged at 12%. So if you make$15,000, the first $10,275 is taxed 10%, and the other$4,725 is taxed 12%.

For a more specialized explanation of specific tax systems, check out these explanations:

What's the difference between the marginal and average tax rates? They are quite similar and often close together numerically; however, they both serve a specific purpose. As established, the marginal tax rate is the taxes paid on earning $1 more than previous. The average tax rate is a cumulative measure of multiple marginal tax rates. The marginal tax rate is about how taxes change as taxable income changes; therefore, the formula reflects this. $$\hbox{Marginal Tax Rate}=\frac{\Delta\hbox{Taxes Paid}}{\Delta\hbox{Taxable Income}}$$ The average tax rate is arguably the real tax rate. However, it can only be calculated after income has been distributed across the qualifying marginal tax brackets. $$\hbox{Average Tax Rate}=\frac{\hbox{Total Taxes Paid}}{\hbox{Total Taxable Income}}$$ A CEO at a tobacco company is complaining about having to pay 37% taxes on his business profits, and it's killing the economy. That is a very high tax rate, but you realize that 37% is only the highest marginal tax rate, and the real rate they pay is the average of all the marginal taxes. You find they earn 5 million dollars a week, and from the tax brackets, you know that the average tax rate on the first$539,9001 is 30.1%, which comes to $162,510 in taxes. $$\hbox{Highest Bracket Income}=\ 5,000,000-\539,900=\4,460,100$$ $$\hbox{Taxable Income @37%}=\4,460,100 \times0.37=\1,650,237$$ $$\hbox{Total Taxes Paid }=\1,650,237 +\ 162,510 =\1,812,747$$ $$\hbox{Average Tax Rate}=\frac{\hbox{1,812,747}}{\hbox{5,000,000}}$$ $$\hbox{Average Tax Rate}=\ \hbox{0.3625 or 36.25%}$$ You check the internet to see if anyone else has done the math to confirm you are correct, only to find you're completely wrong. Due to a tax policy, the company hasn't paid taxes in 5 years. ## Marginal tax rate example To better understand the marginal tax rate, check out these examples below! Your friend Jonas and his brothers are trying to figure out how to file their taxes. They try to calculate it but get confused about the marginal tax rate brackets. They ask you if they can use the average tax rate to save time. Unfortunately, you inform them that the average tax rate can only be calculated after summing the marginal taxes paid at the end. Jonas and his brothers inform you they know they paid 10% taxes on their first$10,275, which is $1,027.5. Jonas says he was charged$2,967 and made $35,000 in total. What did the government tax him? $$\hbox{Marginal Tax Rate}=\frac{\Delta\hbox{Taxes Paid}}{\Delta\hbox{Taxable Income}}$$ $$\hbox{Average Tax Rate}=\frac{\hbox{Total Taxes Paid}}{\hbox{Total Taxable Income}}$$ $$\hbox{Taxable Income}=35,000-10,275=24,725$$ $$\hbox{Taxes Paid}=2,967$$ $$\hbox{Marginal Tax Rate}=\frac{\hbox{2,967}}{\hbox{24,725}}= 12 \%$$ $$\hbox{Average Tax Rate}=\frac{\hbox{2,967 + 1,027.5}}{\hbox{35,000}}=11.41 \%$$ In the example above, we see Jonas and his brothers attempting to understand how marginal tax brackets work. By isolating the tax change and income proportion, we can determine the marginal rate. A joke example that actually was used to write policy in America is Laffer's Curve. Proposed to future policymakers by drawing this graph on a napkin, Arthur Laffer claimed that increases in taxes reduce the incentive to work, resulting in less tax revenue. The alternative is that if you lower taxes, the tax base will increase, and you will receive the lost revenue. This was enacted in policy under what is known as Reaganomics. Fig. 1 - The Laffer Curve The premise of the Laffer Curve was that a tax rate at point A and point B (in Figure 1 above) generate equal tax revenue. The high tax rate at B discourages work, resulting in less money being taxed. Therefore the economy is better off with more market participants at point A. It was believed that these two tax rates generated the same revenue. Therefore the economy would be better off productively at a lower tax rate. This logic implies that higher taxes discourage work, so rather than having a high tax rate on a smaller tax base, have a low tax rate on a higher tax base. Many in congress who advocate for lower taxes will actively bring up Laffer's curve, citing that a decrease in taxes won't hurt tax revenue as it will grow the economy more. This is still used to persuade tax policy despite its premises being critiqued by many economists for decades. ## Marginal Tax Rate - Key takeaways • A marginal tax rate is a change in taxes for making one more dollar. • The United States income tax system uses a progressive marginal tax rate based on fixed income brackets. • The average tax rate is a cumulative sum of several marginal tax rates. It is calculated by dividing total taxes paid by total income. • Marginal tax is calculated by the change in taxes divided by the change in income. ## References 1. Kiplinger, What Are the Income Tax Brackets for 2022 vs. 2021?, https://www.kiplinger.com/taxes/tax-brackets/602222/income-tax-brackets 2. lx, Some Countries Do Your Taxes For You. Here's Why the US Doesn't https://www.lx.com/money/some-countries-do-your-taxes-for-you-heres-why-the-us-doesnt/51300/ ## Frequently Asked Questions about Marginal Tax Rate A marginal tax rate means the change in taxes for receiving$1 more. This occurs in progressive and regressive tax systems.

A marginal tax rate example is the United States income tax system, where as of 2021, the first $9,950 is taxed at 10%. The subsequent$30,575 is taxed at 12%. Another tax bracket begins, and so on.

Understanding a marginal tax rate is important because it can help individuals and businesses determine their labor or investment returns. Would you work harder if you knew you were getting rewarded less?

The marginal tax rate varies depending on your personal income. The income you make in the lowest bracket is taxed at 10%. The income you make after 523,600 is taxed at 37%.

The marginal tax rate varies depending on the income bracket. When all the marginal taxes are added together, it will show the effective tax rate. The effective tax rate is the average tax rate. The marginal tax rate is the tax rate per income bracket.

The U.S uses a marginal tax rate that divides your income by brackets.

## Final Marginal Tax Rate Quiz

Question

What is a marginal tax rate?

A marginal tax rate is a change in tax for earning 1 additional dollar.

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Question

What is the average tax rate?

The average tax rate is the summation of many marginal tax rates and their proportion of income affected.

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Question

What is the formula for the marginal tax rate?

To calculate the marginal tax rate you divide the change in taxes paid by the change in income earned.

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Question

What is the formula for the average tax rate?

The formula for the average tax rate is the total taxes paid divided by the total income taxable.

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Question

What's the difference between the marginal tax rate and the average tax rate?

The marginal tax rate applies to specific portions of income, the average tax rate is the total of all the marginal taxes paid.

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Question

Determine if the following is an example of the marginal tax rate or average tax rate.
I paid 19% taxes on all my income.

Marginal Tax.

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Question

Determine if the following is an example of the marginal tax rate or average tax rate.
I paid 10% taxes on my first $10,000 Show answer Answer Marginal Tax. Show question Question Determine if the following is an example of the marginal tax rate or average tax rate. At first, I paid 12% taxes, then somehow I got charged 23% in taxes later. Show answer Answer Marginal Tax Rate. Show question Question The marginal tax rate is? Show answer Answer A crime. Show question Question What happens to the supply of labor as marginal tax rates increase? Show answer Answer Decreases. Show question Question What happens to the supply of labor as marginal tax rates decrease? Show answer Answer Increases Show question Question Calculate the following marginal tax rates. My first$10,000 was taxed $1,000 My next$10,000 was taxed $2,000 Show answer Answer 10% and 20% marginal tax rate. Show question Question Calculate the following average tax rate. My first$10,000 was taxed $1,000 My next$10,000 was taxed \$2,000

15%

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Question

What does Laffer's Curve imply about marginal tax rates?

That tax increases lower the tax base, resulting in no gain in revenue.

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Question

Does the United States have a marginal tax rate for personal income?

Yes.

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