How Marginal Tax System Works

What is a Marginal Tax Rate?

A marginal tax rate is the rate of tax that income earners have to pay on each additional dollar of income. This means that as the marginal tax rate increases, the income earner has to pay more taxes leaving him with less money per dollar earned than he retained on previous earned dollars. The relationship between the income and the income tax is progressive which means that the higher the income is, the amount of tax imposed thereon likewise increases. However, it must be noted that the income is not all taxed at one rate but at many rates as it moves across the marginal tax rate schedule.

How does Marginal Tax Rate works?

In most marginal tax rates, each dollar of income above the previous level is taxed at a higher rate. Simply, it means that if the taxpayer earns more money and qualifies for a higher income level or bracket, marginal tax rates can significantly diminish the benefit of the additional income since the same will be taxed at a higher rate.

Thus, studies revealed that the marginal tax rate is harmful to the economy due to the fact that it discourages people from working harder to earn money because the more that the worker will earn, the higher the tax that the government will impose on them.

Income are taxed based on the bracket that they qualify in. As the income qualifies for another bracket, the tax likewise increases. But, when a new marginal rate is reached, said rate applies to all taxable income found within that rate level. Similarly, the income found below said level will be taxed at a lower rate.

Marginal tax rates are also being used in other countries such as Australia, Canada, Finland, Germany, Denmark, Italy, Japan, Great Britain, Switzerland and France.

This system brought advantages and disadvantages to the taxpayers. One if its famous advantage is that low income earners will be taxed at a lower rate as compared to higher income earners. However, the downside of said system, as critics allege, is that it is an incentive against working harder. According to the critics of the system, it discourages the taxpayers from working harder since alongside with the increase in income is the increased tax rate imposed by the government.

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