What’s The Purpose Of Income Tax Brackets?
Most countries have a ‘progressive’ tax system. This means that people with more income pay a higher percentage of that income in tax. In the US, this system is put into practice via the use of tax brackets.
But what are tax brackets? Why do we need them? And what are the current tax brackets in the US? Keep reading for answers to these questions.
What are tax brackets?
Tax brackets are different tax rates that apply to different levels of earnings. Let’s look at an example.
Imagine that there are three tax brackets: 10%, 25%, and 40%. The 10% rate applies to income from $1 to $10,000; the 25% rate applies to income from $10,001 to $20,000; and the 40% rate applies to all income above $20,000.
In this tax system, if you earned $10,000 your income would be taxed at a rate of 10% and you’d pay $1,000 in tax. If you earned $7,000 you would pay $700 in tax, and so on.
However, if you earned $35,000 you would face a more complicated calculation. The rate on the first $10,000 would be 10%; the rate from $10,001 to $20,000 would be 25%; and the rate above that would be 40%. You would pay $1,000 for the first $10,000 of your income, $2,500 for the second $10,000 of your income and $6,000 for the last $15,000 of income.
In total you would pay $9,500. This is about 27.1%. In this case, 27.1% is your ‘average’ tax rate, whilst 40% is your ‘marginal’ tax rate – the rate at which you pay tax on the last dollar of your income.
Why do we have tax brackets?
There are several reasons why the US has tax brackets. These include:
- Fairness – Advocates of progressive tax systems often say that ‘rich people can afford to pay more.’ What they mean is that $100 means more to a person making $5,000 a year than it does to a person making $500,000 a year. This means that allowing poor people to keep a larger share of their income will result in a happier society than making everyone pay the same rate
- Helping ‘public goods’ – Making wealthier people pay more tax allows us to produce more public goods and services that benefit everyone
- It encourages economic activity for the lower and middle classes
What are the tax brackets in the US?
There are six tax brackets in the US: 10%, 15%, 25%, 28%, 33% and 35%. What tax you pay depends on your filing status and the amount of taxable income you earn.
The tax brackets for 2012 are:
| Tax rate | Single | Head of Household | Married Filing Jointly or Surviving Spouse | Married Filing Separately |
| 10% | Up to $8,700 | Up to $12,400 | Up to $17,400 | Up to $8,700 |
| 15% | $8,701 to $35,350 | $12,401 to $47,350 | $17,401 to $70,700 | $8,701 to $35,350 |
| 25% | $35,351 to $85,650 | $47,351 to $122,300 | $70,701 to $142,700 | $35,351 to $71.350 |
| 28% | $85,651 to $178,650 | $122,301 to $198,050 | $142,701 to $217,450 | $71,351 to $108,725 |
| 33% | $178,651 to $388,350 | $198,051 to $388,350 | $217,451 to $388,350 | $108,726 to $194,175 |
| 35% | $388,351 or more | $388,351 or more | $388,351 or more | $194,176 or more |
I don’t understand the difference between ‘average’ tax rate and ‘marginal’ tax rate. Can you explain?
Betty – thanks for your question.
In a system that has tax brackets, you won’t generally pay all your tax at the same rate. You might pay some tax at 10% and some at 15%. Higher earners may pay tax at several different rates. So, your ‘average’ tax rate is simply the average rate of tax that you pay.
Your ‘marginal’ tax rate is the highest rate of tax that you pay. It’s the tax rate you pay on the final dollar of your earnings and is likely to always be higher than your ‘average’ tax rate.