Well, I’m finally back after a few weeks off! I thought I would start the new year with an article about the U.S. marginal tax rate system. We’ll be electing a new president this year, and I think it’s important that people understand how our current Federal tax system works.
After all, the candidates are proposing new tax plans. Citizens need to be able to compare what we currently have to their proposals.
The U.S. has a progressive marginal tax rate system. This means that the more money we make, the higher the tax rate we pay. But you don’t have to pay that higher tax rate on everything you make. Here are the marginal tax rates for single payers in 2016:1
Breaking Down the Math
For the first $9,275 of income, you’ll pay just 10%. If you made $5,000 during 2016, you’d pay 10%, which is $500. And if you made $9,275, you’d pay 10%, which is $927.50.
But let’s say you made $15,000. In that case, you’d pay 10% on the first $9,275 and 15% on the amount between $9,275 and $15,000. So you’d pay $927.50 ($9,275 * 10%) plus $858.75 ($5,725 * 15%), which equals $1,786.25. And what percentage is that of the $15,000 you made? It works out to 11.9%.
Let’s define some terms. Your marginal tax rate is the amount you’ll pay on each additional dollar you make. In the example above where you made $15,000 for the year, your marginal tax rate is 15%. It’s 15% because every additional dollar you made would be taxed at 15%.
Your effective tax rate is the average percentage you pay on all your income. So, your effective tax rate if you made $15,000 in 2016 would be 11.9%.
If you look a little lower on the chart, you’ll see some of the higher tax brackets. Going by that chart, if you made $120,000 in 2016, your Federal tax bill would be $26,636.47. In this case, your marginal tax rate would be 28%, and your effective tax rate would be 22.2%.
In reality, it’s a bit more complicated than I’ve described it above. I wanted to keep our example simple, but the U.S. tax code is decidedly not simple. There are many deductions you can take before paying any taxes. For example, a single person who does not itemize their deductions can take a standard deduction of $6,300. This means they won’t pay Federal taxes on the first $6,300 they make in 2016.2 They can also deduct many other items, such as contributions to a 401k or Roth IRA.
So a single person who made $15,000 in 2016 would probably pay far less than 11.9% of their total income towards Federal taxes. In fact, it’s possible they wouldn’t pay any Federal taxes at all. Of course, they would still pay towards Social Security and Medicare, as well as sales tax and property taxes.
I might offend some people with what I have to say next. But I have my opinion and I want to share it with my readers. Though the U.S. tax code is complicated, I think a marginal tax system is the only type of system we should have. Poor people should pay a lower percentage in taxes than rich people. Many presidential candidates are currently recommending a flat tax. They say it’s only fair that everyone should pay the same percentage. Whether they recommend 15%, 20% or some other rate, I don’t agree.
As I said above, a person making $15,000 a year might not pay any Federal income taxes, but they’ll definitely pay other taxes. In fact, the other taxes they pay could add up to as high as 12-15%. And they definitely cannot afford to pay another 15 or 20% flat tax on top of that. In most parts of the country, they probably can’t get by on $15,000 a year to begin with. That’s a gross income of just $1,250 per month…before taxes.
On the other hand, a wealthy person making $500,000 per year would currently pay $154,169.55 in Federal taxes, if they didn’t take any deductions. The reality is they would actually pay far less than this, because there are many deductions available to them. But we’ll ignore that for now. They would also pay a low percentage of their income towards Social Security and Medicare, as you only pay those on the first $118,500 of income. But we’ll ignore that as well for the moment.
$154,169.55 is an effective tax rate of 30.8%. That is the cost to live in a country with all the benefits the U.S. has. And the wealthy person in this example is much better equipped to pay that 30.8% than a poor person would be equipped to pay 15-20%.
Do you disagree with me? Leave a comment below.