Marginal Tax Brackets
In yesterday's post about Joe The Plumber, mmcirvin set me straight about something that I have been totally wrong about for a very long time, and I expect that others might be mistaken about. Consider the following (extremely simplified) tax brackets:
$0-$20K : 0%
$20K-$80K : 15%
$80K-$200K : 25%
>$200K : 35%
I'd always thought of brackets as being absolute. If Joe made $79,000 per year he'd be in the 15% bracket and if he got a $2000 raise he'd be in the 25% bracket. And I'd assumed *that* meant his income worked out like this:
$79,000 - (15% : $11,850 tax) = $67,150 take-home
$81,000 - (25% : $20,250 tax) = $60,750 take-home
Thanks to his $2000 raise, Joe ends up paying $8400 more in taxes and getting $6400 less total money. Does that seem fair to you? It shouldn't. Which is why it doesn't actually work this way.
The way I think it actually works is that Joe earns his first $20K and pays 0% tax. The next $60K gets taxed at 15%. Only the marginal amount that puts him over $80K gets taxed at 35%. So Joe's actual "before and after" taxes would be:
$79,000 : $20K*0% + $59K*15% = $8850 tax : $70,150 take-home
$81,000 : $20K*0% + $60K*15% + $1K*25% = $9250 tax : $71,750 take-home
The way that taxes are actually calculated, Joe's $2000 raise actually works out to $400 more taxes and $1600 more take-home pay, which is a lot more fair.
Update: This is an especially important concept to understand when comparing the McCain and Obama tax proposals. Everyone gets tax cuts on their first $227,000. The tax hikes in higher brackets are necessary to offset the tax cuts that the rich already get from Obama in the lower brackets.
Update2: If you’re freaked out about taxes, please make sure you actually know what you’re talking about when it comes to taxes.
$0-$20K : 0%
$20K-$80K : 15%
$80K-$200K : 25%
>$200K : 35%
I'd always thought of brackets as being absolute. If Joe made $79,000 per year he'd be in the 15% bracket and if he got a $2000 raise he'd be in the 25% bracket. And I'd assumed *that* meant his income worked out like this:
$79,000 - (15% : $11,850 tax) = $67,150 take-home
$81,000 - (25% : $20,250 tax) = $60,750 take-home
Thanks to his $2000 raise, Joe ends up paying $8400 more in taxes and getting $6400 less total money. Does that seem fair to you? It shouldn't. Which is why it doesn't actually work this way.
The way I think it actually works is that Joe earns his first $20K and pays 0% tax. The next $60K gets taxed at 15%. Only the marginal amount that puts him over $80K gets taxed at 35%. So Joe's actual "before and after" taxes would be:
$79,000 : $20K*0% + $59K*15% = $8850 tax : $70,150 take-home
$81,000 : $20K*0% + $60K*15% + $1K*25% = $9250 tax : $71,750 take-home
The way that taxes are actually calculated, Joe's $2000 raise actually works out to $400 more taxes and $1600 more take-home pay, which is a lot more fair.
Update: This is an especially important concept to understand when comparing the McCain and Obama tax proposals. Everyone gets tax cuts on their first $227,000. The tax hikes in higher brackets are necessary to offset the tax cuts that the rich already get from Obama in the lower brackets.
Update2: If you’re freaked out about taxes, please make sure you actually know what you’re talking about when it comes to taxes.