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

The marginal tax rate is - but also isn't - the rate at which you pay taxes. Don't worry, it's not as confusing as it sounds...
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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 based on 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 based on 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 out of 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 like 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 like 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 like a 70% marginal tax rate on millionaires, what she means is that (for better or for worse) she would like to take 70 cents out of 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.