There’s been a lot of talk, and confusion, in the news recently about income tax rates, and marginal tax rates in particular, and anytime someone in the news mentions anything ‘marginal’ economists get overly excited. Here’s a quote from a Bloomberg article that posted about an hour ago:
Billionaire Michael Dell, chief executive officer of the eponymous technology giant, rejected a suggestion by U.S. Representative Alexandria Ocasio-Cortez of a 70-percent marginal tax rate on the wealthiest Americans.
I’m not going to get into a debate over whether a 70% marginal tax rate is a good idea or not–or even the pros and cons. Instead, I just want to make sure we understand how tax rates work in the U.S.
Income taxes in the U.S. are set up based on tax brackets. A bracket is an income category. For example, right now, the lowest tax bracket for a single tax-payer is for income up to $9,525. The marginal tax rate for this lowest income bracket is 10%.
Now, some people think that this tax rate doesn’t apply to them. After all, most tax-filing working adults make more than $9,525. But ‘some people’ would be wrong. The lowest bracket 10% marginal tax rate applies to the first $9,525 ANY single tax payer makes. Whether you made exactly $9,525, or $95,250, you pay the same $952.50 on the first $9,525 you make.
So what happens when your income goes above $9,525? The next tax bracket is for income you make from $9,526 to $38,700. For each dollar in this bracket you are taxed a marginal rate of 12%. So let’s suppose you make $31,200 a year (that’s $15/hour for 2080 hours). How much will you pay in taxes?
It’s tempting to just multiple $31,200 by 12% and get a tax bill of $3,744. But don’t give into that temptation. The 12% marginal tax rate only applies to dollars in that income bracket (dollars $9,526 through $31,200). So you will pay 12% on $21,675 ($31,200-$9,525). That’s a tax bill of $2,601 on that income, but you have already paid 10% of the first $9,525 you earned ($952.50). So your total tax bill is $2,601+$952.50 = $3,553.50.
Notice that your tax bill is actually less than if you had just multiplied your full income by the 12% marginal tax rate. This means that your effective tax rate is actually lower than your actual tax rate. In fact, you can calculate your effective tax rate by dividing your tax bill $3,553.50 by your income $31,200 and multiply by 100 to get an effective tax rate of 11.4%.
This same process for calculating taxes and tax rates keeps going as your income goes up. There are currently seven income brackets in the U.S. tax code and seven marginal tax rates. The highest marginal tax rate currently is 37%, and that applies to ever dollar you earn above $500,000. That applies to less than 1% of all single tax payers in the U.S.
So what then is the 70% marginal tax rate proposal?
The 70% proposal is to add another income bracket for those who earn more than $10,000,000..PER YEAR! So if someone earns $10,000,0001 next year, they would pay $0.70 more in taxes than someone who earns only $10,000,000 (who falls in the 37% tax bracket).
And just for fun, what is the effective tax rate for someone earning $10,000,000 per year? With a tax bill of $3,665,690.20, the effective tax rate is 36.7%
Compare that to someone making $11,000,000 per year. Their tax bill would be $4,365,689.50 for an effective rate of 39.7% — far below the marginal rate of 70%.