Personal Finance / Unit 7: Taxes
7.5 Tax Brackets Explained
Notes
In a progressive income tax, higher slices of income are taxed at higher rates. Only the income inside each bracket is taxed at that bracket's rate. This is the marginal rate.
- Made-up brackets: 10% on the first $10,000; 20% on income from $10,000 to $40,000; 30% on income above $40,000.
- Example: taxable income $20,000. Tax $= 0.10 \times 10000 + 0.20 \times 10000 = 1000 + 2000 = 3000$.
- Effective rate = total tax $\div$ taxable income. Here $\displaystyle \frac{3000}{20000} = 15\%$.
- A raise never makes your whole income jump into a higher rate. Only the extra dollars are taxed at the higher rate.
Practice
Using the made-up brackets 10% on the first $10,000 and 20% above that, what is the tax on $15,000?
$0.10 \times 10000 = 1000$ and $0.20 \times 5000 = 1000$, total $2,000.
Tax is $3,000 on taxable income of $20,000. What is the effective tax rate?
$\displaystyle \frac{3000}{20000} = 0.15$.
A raise moves a worker into a higher bracket. What happens under a progressive system?
The higher rate applies only to the extra income inside the new bracket.
Ready for more? Take the Unit 7 test.