How Marginal Income Tax Works

Estimated Quarterly Tax

A tax can be either regressive or progressive.

Under a regressive tax, everyone pays the same tax rate.

While this sounds equitable, it actually places a greater burden on people with lower incomes. Take sales tax, for instance.

Let’s say that sales tax is 7%. If you make $20,000 per year and purchase an item for $1,000, you will spend $70, or 0.35% of your income, on sales tax.

If, however, you make $100,000 per year, the sales tax on that same $1,000 purchase accounts for only 0.07% of your income.

As your income creeps higher, your tax burden becomes less and less.

On the other end of the spectrum is a progressive tax.

With a progressive tax, the tax rate increases as income increases, so the tax liability is based on an individual’s ability to pay rather than on an arbitrarily assigned tax rate.

A progressive tax structure forms the basis of the American income tax.

Under our system, income is divided into brackets with higher brackets paying higher tax rates.

Here’s the current tax table:

Taxfoundation.org

Under a pure progressive tax system, you would pay the tax rate associated with the bracket within which your income falls.

However, the American tax system is marginal, so instead of paying one tax rate on all your income, you pay each tax rate on the portion of your income that falls within the corresponding tax bracket.

Let’s look at an example.

If you’re married and filing a joint return and your annual household income is $50,000, you would pay 10% on the first $19,049 of your income and an additional 2% tax on the portion of your income above $19,049.

While your income technically places you in the 12% tax bracket, you would owe 11.2%, or $5,619.

By assessing a greater tax rate on marginal increases in income rather than on total income, a marginal tax reduces the statutory tax rate, saving you some of your hard-earned money.

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