What Are Marginal Tax Rates?

Tax form business financial concept with a pen and a calculator aside.

Marginal tax rates are the rate at which you’ll pay taxes based on your income. The federal government adjusts these rates every year to account for changes in the cost of living. If you’re unsure about what percentage you’ll pay, it’s a good idea to consult with a tax advisor.

Marginal tax rates affect the allocation of income between different asset types. For example, the tax rates on capital gains are lower than those on dividends. This gives households with high marginal tax rates an incentive to focus their portfolio on shares that produce capital gains. However, this is not always the best approach. Many economists advocate a compromise solution based on the notion of “input factor neutrality.”

If a married couple earns a combined salary of $110,000 and has two children, the top marginal tax rate is 22 percent. However, after deducting all the other expenses, their taxable income is only $63,000. To determine the appropriate federal income tax rate for your situation, it is helpful to look up the federal tax brackets. The federal tax brackets are different than the state tax rates. The federal income tax brackets are determined by the Internal Revenue Service, and are updated every year to account for inflation.

The Congressional Budget Office estimates that increasing marginal tax rates by a percentage point will increase federal revenue by $114 billion from 2021 to 2030. Larger percentage increases would result in much larger revenues. These tax rate changes, however, are not without risk. For example, an individual may have to take on additional risks in order to increase his or her income. A person may need to relocate to a new city or work late at night in order to earn more money.

Marginal tax rates are calculated by dividing the tax burden on an individual by the amount of income that the person earns. As income increases, the marginal rate increases with it. Therefore, higher marginal rates reduce economic incentives. A higher marginal rate results in lower incentives for working and consuming. This in turn reduces household economic activity.

While the marginal tax rate represents a percentage of your gross income, it doesn’t take into account any surtaxes, deductions, or credits. These other factors can greatly impact your tax burden. For example, a royalty rate of 8% would mean a marginal tax rate of 0.41. As a result, the marginal tax rate is different from the statutory flat rate of 41%.

In addition to marginal tax rates, the CBO also calculates an effective tax rate. The effective tax rate measures the percentage of income that you pay in taxes as opposed to the percentage of your income that is not taxable. This measure is more accurate and gives a more accurate picture of the tax burden you face.