A:

The marginal tax rate is the rate of tax that income earners incur on each additional dollar of income. As the marginal tax rate increases, the taxpayer ends up with less money per dollar earned than he or she had retained on previous earned dollars. Tax systems that employ marginal tax rates apply different tax rates to different levels of income; as income rises, it is taxed at a higher rate. It is important to note, however, that the income is not all taxed at one rate but at many rates as it moves across the marginal tax rate schedule.

The above is a simple example of a marginal tax rate schedule. It illustrates the rate at which various levels of income are taxed. As income rises, each dollar of income above the previous level is taxed at a higher rate. If a taxpayer earns more money and moves into a higher income level, marginal tax rates can significantly diminish the benefit of the additional income because it will be taxed at a higher rate. As a result, some believe that marginal tax rates are harmful to the economy because they discourage people from working harder to earn more money. However, it is important to note that although earning more money may increase income tax rate, a larger income will still be taxed at more than one level. The chart below illustrates how marginal tax rate works.

As the graph shows, it may be best to think of the example in terms of income that is growing from \$0 to \$120,000. As it moves towards \$120,000 it incurs different tax rates. Therefore, income between \$0 and \$20,000 is taxed at 10%, so the tax owed is \$2,000 (\$20.000 x 10%). Then income moves into a new marginal tax rate (20%). As it grows above \$20,000, the \$120,000 income earner owes \$4,000 in tax (\$20,000 x 20%) for this portion of income in addition to the \$2,000 of tax incurred on the first \$20,000. This is done at each income level up to the taxpayer's total income, in this case, \$120,000. Based on the tax rate schedule above, the \$120,000 income earner pays a total of \$38,000 in taxes based on the marginal tax rate system. This example also illustrates that not all of this taxpayer's income is taxed at the same rate. Therefore, only \$2,000 of tax is owed at the lowest income level, while \$6,000 of tax is incurred at the third level on the same amount of money (\$20,000). Many people are confused by marginal tax rates, believing that the rate at which they will be taxed is a flat rate based on the income level into which they fall. According to this incorrect assumption, therefore, a \$120,000 income would be taxed at a 50% rate, making the amount of tax owed \$60,000.

For additional reading, see Tax Tips For The Individual Investor and Using Tax Lots: A Way To Minimize Taxes.

RELATED FAQS
1. ### Is the marginal tax rate a progressive tax?

Learn how the marginal tax rate is a progressive tax that takes a higher percentage of income tax from high-income earners ... Read Answer >>
2. ### What's the difference between the marginal tax rate system and a flat tax?

Find out about the difference between marginal tax rates and flat taxes. Gain insights on both systems and the arguments ... Read Answer >>
3. ### How does the effective tax rate for an individual differ from that of a corporation?

Read about the effective tax rate for individuals when compared with the effective tax rate for corporations, including how ... Read Answer >>
4. ### What is the income breakdown for the effective tax rate?

Read about the effective tax rate, how the marginal income tax brackets affect it and how the denominator in its formula ... Read Answer >>
5. ### How are effective tax rates calculated from income statements?

Learn how to read an income statement and how to find the information necessary to calculate a company's effective income ... Read Answer >>
Related Articles
1. Taxes

### Which Countries Have the Highest Taxes on High Incomes?

These countries charge the highest taxes on high incomes.
2. Taxes

### How Tax Cuts Stimulate the Economy

Learn the logic behind the belief that reducing government income benefits everyone.
3. Taxes

### Comparing Regressive, Proportional and Progressive Taxes

Learn about the basic differences between three common tax systems.
4. Taxes

### The History Of Taxes In The U.S.

The number of taxes that we now consider a given did not always exist. Find out how they arose.
5. Taxes

### How Getting A Raise Affects Your Taxes

Many people think they may actually make less overall because they are paying more taxes.
6. Taxes

### Explaining Progressive Tax

A progressive tax is a levy in a tax system where the tax rate increases as the taxable base increases.
7. Taxes

### Countries with the Highest Income Taxes

Before you move to one of these countries with the highest income taxes, think through the overall tax situation - and what you get for your money.
8. Taxes

### Understanding Income Tax

Income tax is a levy many governments place on revenue of entities within their jurisdiction.
9. Managing Wealth

### What is the Effective Tax Rate?

The effective tax rate is the average rate at which an individual or corporation is taxed per year.
10. Taxes

### Breaking Down Taxes For Different Income Brackets

Here is a useful rundown of how much you will pay in taxes based on your income.
RELATED TERMS
1. ### Tax Rate

A tax rate is the percentage at which an individual or corporation ...
2. ### Effective Tax Rate

The average rate at which an individual or corporation is taxed. ...
3. ### Dual Rate Income Tax

An income tax rate structure in which two different tax rates ...
4. ### Marginal Tax Rate

The amount of tax paid on an additional dollar of income. The ...
5. ### Tax Base

The assessed value of a set of assets, investments or income ...
6. ### Flat Tax

A system that applies the same tax rate to every taxpayer regardless ...
Hot Definitions
1. ### Racketeering

A fraudulent service built to serve a problem that wouldn't otherwise exist without the influence of the enterprise offering ...
2. ### Aggregate Demand

The total amount of goods and services demanded in the economy at a given overall price level and in a given time period.
3. ### Fixed Cost

A cost that does not change with an increase or decrease in the amount of goods or services produced. Fixed costs are expenses ...
4. ### Blue Chip

A blue chip is a nationally recognized, well-established, and financially sound company.
5. ### Payback Period

The length of time required to recover the cost of an investment. The payback period of a given investment or project is ...
6. ### Collateral Value

The estimated fair market value of an asset that is being used as loan collateral. Collateral value is determined by appraisal ...