Question

Explain how the marginal tax brackets work. How does an increase in the tax at the highest tax bracket affect those making less than $50,000 a year? How does this relate to the idea of inequity?

Answer 1

Payment of tax on the last dollar of income is marginal tax.

An imaginary marginal tax bracket is taken below:

Marginal tax rate	Taxable income bracket	Tax liability
10%	$0 to $20,000	10% of taxable income
15%	$20,001 to $50,000	$2,000 plus 15% of excess over $20,000
25%	$50,001 to $90,000	$6,500 plus 25% of excess over $50,000

In each row, marginal tax increases as income increases; this is the indication of progressive tax system. Suppose a taxable income is $32,000.

At 15% tax bracket:

Tax liability = Full tax from 10% bracket + Marginal tax at 15% bracket

                        = ($20,000 × 10%) + (32,000 – 20,000) × 15%

                        = $2,000 + 12,000 × 15%

                        = 2,000 + 1,800

                        = $3,800

The tax liability would be $3,800 if the taxable income is $32,000.

Since there is progressive tax system, the highest tax bracket is at 25% marginal tax rate for the income more than $50,000; the amount of tax increases as taxable income increases. Such high rate of tax is not applicable to the lower income group (people earning less than $50,000); the tax rate is still remaining 15% or 10% for the income less than $50,000.

This is the idea of inequality – higher income group afford to pay high tax; therefore, they are charged more compare to lower income group. This is the way of protecting lower income group.