Understanding how marginal tax rate works
In general, marginal tax rate refers to the amount of tax that each dollar of income is accounted for. However, to understand how it works, one needs to first, dissect the clause “marginal tax rate”. In many countries, tax operates in a progressive manner, which means the higher the income, the higher the amount one will be taxed. Marginal, in this case, will refer to what occurs at the end of one’s income.
Next, assuming incomes are divided into various sections, for examples, less than $20K; between $20K and $40K; between $40K and $60K; between $60K and $100K, and over $100K. Each of these sections will have a different marginal income tax or tax bracket, for examples, 10% for those earning less than $20K; 20% for those earning between $20K and $40K, 30% for income between $40K and $60K, 40% for income between $60K and $100K, and 50% for those more than 100K.
Under this rate, if a person’s income is $55,000 per annual, he/she will fall into the 30% category, which means he/she will have to pay the amount calculated in the 10%, 20%, and 30% categories, making his/her tax to be,
($20,000 – $0) x 10% = $2000
($40,000 – $20,000) x 20% = $4000
($55,000 – $40,000) x 30% = $4500
$2000 + $4000 + $4500 = $10,500
Do take note that, tax bracket remained unchanged for each category, however, the way in which one is being taxed may vary depending on factors like if he/she is single, how much asset he/she owns, or if he/she is the head of the household etc. Each country will have a different amount cater for the tax bracket and the extent to which one is exempted of certain taxes, but the overall calculations are rather similar.
Although it may be a little complicated for amateur, marginal tax rate is a fair way of ensuring people of different income are paying different amount of tax and people having a higher income are responsible for paying more than those who are of a lower income.
Nevertheless, some critics are calling for a flat rate, that is the same amount of tax for everyone, regardless of their income. As these people believe that higher earner also signifies working harder, thus they should not succumb to higher payment.