Understanding Tax Brackets and Marginal Tax Rates

Common Misunderception

• People often think that being in a particular tax bracket means paying that percentage on the entire income.
• Example: For an income of $84,000, it's wrong to assume a 22% tax on the entire amount.

How Tax Brackets Actually Work

• Special Pocket:
  • Certain amount of income is not taxed ($12,000 for singles, more for couples).
  • Additional deductions possible for expenses like medical and charitable donations.
• Remaining Income:
  • After deductions, remaining income is divided into different 'pockets' based on tax brackets.

Breakdown of Taxable Income

• Pocket Structure:
  • First Pocket:
    • Up to $9,700 is taxed at 10%.
  • Next Pocket:
    • Income above $9,700 is taxed progressively at 12%, then 22%.
• This progression is known as marginal tax rates.

Effect of Raises

• How Raise is Taxed:
  • New income from a raise is distributed into pockets with remaining space.
  • Only the additional income might be taxed at higher rates if it fills into higher pockets.

Political Implications

• Changes in top tax rates do not necessarily affect all income.
• Top rates apply only after filling smaller pockets.
• Marginal tax rates clarify misunderstandings about proposed tax changes.

Conclusion

• Marginal tax rates simplify understanding of taxation.
• Avoid panic over tax rate changes by understanding which portions of income are affected.