The standard definition of the marginal tax rate is that it's the amount of tax imposed on every last dollar of income. Sound simple? Maybe. But just what is someone's last dollar of income and what tax rate might apply to it?
To help sort out the rather 'taxing' idea behind marginal tax rates, CNBC explains.
What is a marginal tax rate?
We'll start first with the fact that the U.S. tax system is a progressive tax. That means as someone's income increases, their tax rate increases too.
This is where the idea of a marginal tax rate comes in. Marginal refers to what's happening at the 'margins' or ends of someone's income, not on the total income. Simply put, someone's income is divided into sections of amounts and those sections each have a different marginal tax rate.
Does a marginal rate apply to someone's total income?
No. Income in a certain bracket is only taxed at the marginal rate set for that bracket. As income gets higher or moves beyond a section, the marginal tax rate will increase.
However, once a new marginal rate is reached, that rate applies to all taxable income within that rate level and only within that level. Likewise, the income earned below that level is taxed at the lower marginal rate.
What are the current marginal tax rates?
Marginal tax rates can and do change but here are the current rates:
For a single individual:
•10% on taxable income from $0 to $8,700
•15% on taxable income over $8,700 to $35,350
•25% on taxable income over $35,350 to $85,650
•28% on taxable income over $85,650 to $178,650
•33% on taxable income over $178,650 to $388,350
•35% on taxable income over $388,350.
For a married couple filing jointly:
•10% on taxable income from $0 to $17,400
•15% on taxable income over $17,400 to $70,700
•25% on taxable income over $70,700 to $142,700
•28% on taxable income over $142,700 to $217,450
•33% on taxable income over $217,450 to $388,350
•35% on taxable income over $388,350.
How would a typical set of marginal rates work?
Here's an example, as we look at a single individual taxpayer's income of $200,000 using the rates listed above. Remember, the increasing marginal rates only apply to one income bracket and not the total amount.
So, income between $0 and $8,700 is taxed at a marginal rate of 10 percent—and the tax owed is $870 for that bracket. Then income moves into a new marginal tax rate of 15 percent as it grows above $8,700 with a top of $35,500. That tax due on that income of $26,650—$35,350 minus $8,700—is $3,997.50.
The next income bracket $35,350 to $85,650 is taxed at 25 percent. So, the amount owed for this bracket—$85,650 minus $35,350 for a total of taxable income of $50,300—is $12,575.
The second to last bracket for the $200,000 salary has a marginal rate of 28 percent. So as we use the formula, the tax required for this comes out to $26,040 as we subtracted $85,650 from $178,650 to get the taxable income of $93,000.
So the last bracket and tax rate for the $200,000 salary is 33 percent. To figure how much income is taxed at that rate, we subtract $178,000 from $200,000 for a figure of $21,300. At 33 percent, the taxes owed on that $21,300 is $7,045.
So the total tax due is $50,527.50 on an income of $200,000. However, this figure does not mean someone would actually owe that amount. There are numerous deductions and other factors to lessen or raise the tax bill.
Do other countries besides the U.S. have marginal rates?
Yes. Australia, Canada, Finland, Germany, Denmark, Italy, Japan, Great Britain, Switzerland and France are among the group of nations using marginal tax rates. Belgium is said to have one of the highest marginal tax rates—at a top rate of 54 percent.
What are the pros and cons of marginal tax rates?
This method of taxation aims to fairly tax individuals based upon their earnings, with low income earners being taxed at a lower rate than higher income earners.
On the other hand, critics of marginal tax rates say it's an incentive against working harder and making more money because of the increasing tax rates. They call for a flat rate, or one rate for all income.
Studies have proven somewhat inconclusive as to whether marginal rates hinder worker production.