Marginal tax rate

A marginal tax rate is the percentage of tax paid on an additional dollar of income. In a progressive income tax system, income is divided into brackets, and each rate applies only to the portion of income that falls within that bracket. A taxpayer whose income moves into a higher bracket pays the higher rate only on the amount above the threshold, not on all income.

For example, with brackets of 10 percent on the first portion and 12 percent above it, a person earning just over the line pays 12 percent only on the extra dollars. The effective tax rate is the total tax divided by total income and is always lower than the top marginal rate in a progressive system. Marginal rates may also be raised implicitly by the phase-out of credits and benefits, which creates hidden high rates for some low earners.

Economists focus on marginal rates because they determine the reward for working more, saving or investing, which is the core of supply-side economics and the laffer curve. Conservatives usually advocate lower marginal rates, and some prefer a flat tax; others prioritize progressivity and argue that higher earners can afford higher rates. Evidence indicates that behavioral responses are strongest for high earners and for reporting of income.