Making Sense of Marginal Tax Brackets

 

Marginal tax rate bracket is the categorization of income earners according to their additional income and the rate for which they will be charged for the added income. An earning person’s marginal tax brackets refer to the assortment of income for which is applied a given marginal tax rate. It refers to the segregation at which tax rates changes in a progressive tax system. In a nutshell, they represent the borderline values for an income to be subject to tax. This implies that an income that is past a given point will be levied at a higher tax rate.

Marginal taxes are tax rates on every additional dollar in income. Because income taxes are taxed in a progressive manner, any additional dollar in income will be taxed at a higher rate as opposed to all incomes preceding it. As such, additional income will pad the existing taxes on income, raising taxes to be paid to a higher level.

A person’s marginal tax rate may vary as his income or consumption varies, classifying him in any of the marginal tax rate bracket. But taxes, particularly income taxes, being structured progressively, the average tax rate will be lower than the marginal tax rate. Marginal tax rates are of high importance because the usually set inducement to increase income.

Determining Marginal Tax Rates

In any discussion on marginal taxes, two terms always come to mind: the average tax rate and the marginal tax rate. The average tax rate is easier to compute as it simply means total taxes paid divided by income. On the other hand, marginal tax rates are the amount that must be paid on the last dollar of income.

Because marginal tax rates pads up the average tax, it is of relevant importance to consider whenever a person has to make a choice on whether or not to put in an extra hour of work because income earned per additional work means an additional tax to shoulder.

In the U.S., the marginal tax rates starts at zero, rises to 15 percent, then to 28, 31, 36, and finally to 39.6 percent. Most of the taxpayers shoulder a marginal tax rate of 15 per cent.

Before the 1986 U.S. tax reform, the tax rate schedule contained many a marginal tax rate bracket with marginal tax rates ranging from 11 percent to 50 percent. In 1993, the highest marginal tax rates were increased from 31 percent to 39.6 percent.

The pre-1986 system was somewhat more progressive at the highest levels of income, but it actually taxed low-income taxpayers more than the current system does. If the old system were still in place, it would only raise slightly more revenue than the present system. The reason behind this is that although the pre-1986 system taxed most income at higher rates, it left a much higher fraction of income exempt from tax wholly or if taxed, only at reduced rates.

Marginal tax rate bracket is applied only whenever an income surpasses the highest tax rate for taxable income. As such, not all income is subjected to it, only those who exceed the highest rate.

Factors Affecting the Taxation System

In discussions relating to tax rates, two terms usually pop up: exemptions and deductions, depending on the marginal income tax bracket. Both terms reduce the amount of income subjected to tax albeit they do so differently. Exemptions apply to specific categories of income that are not taxed while deductions apply to specific categories of expenditure.

Both exemptions and deductions are called tax expenditures in the sense that they reduce the government’ budget surplus. However, unlike direct expenditures, tax expenditures work by reducing tax revenue rather than by increasing spending. Both deductions and exemptions generally make progressive income taxes less progressive in practice than it seems on paper.