Marginal tax rate

The marginal tax rate is the amount of tax paid on the last dollar of income. When a taxing authority imposes a tax structure in which the tax rate increases with the income level, a taxpayer is required to pay an increasing amount of taxes as his taxable income increases. The intent behind having an increasing marginal tax rate is to impose a lower tax on low-income individuals, which is subsidized by the higher tax paid by higher-income individuals.

A marginal tax structure is comprised of a series of income ranges, each one having a tax rate associated with it. When a taxpayer's income increases enough to move into the next highest income range, a new tax rate is applied to it. The taxpayer will continue to pay that tax rate until his income moves into the next highest income range.

The calculation of a person's tax is not based solely on the marginal tax rate. Instead, the taxpayer pays the lowest tax rate for his initial tranche of income, followed by the next lowest tax rate for his next tranche of income, and so forth. Thus, a person who pays the highest possible marginal tax rate may pay an average rate that is significantly lower than the top marginal tax rate.

A potential problem with an excessively high marginal tax rate is that it creates a disincentive for high income taxpayers to earn more money. This is because the government is taking so much of their incremental taxable income that it is not worthwhile to earn more money.