what is marginal tax rate?

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sksbog
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what is marginal tax rate?

Post by sksbog » Fri Feb 16, 2018 7:39 pm

Hi Bogleheads,

very basic question. What is marginal tax rate?
Turbotax shows my tax bracket 28% and effective tax rate 18.5%.

What is my marginal tax rate?

Thanks

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whodidntante
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Re: what is marginal tax rate?

Post by whodidntante » Fri Feb 16, 2018 7:42 pm

It's the tax rate you paid on the last dollar earned.

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steve roy
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Re: what is marginal tax rate?

Post by steve roy » Fri Feb 16, 2018 7:52 pm

A person's marginal tax rate is the highest rate at which an individual's maximum earnings (the last dollar of taxable income that an individual earns) is taxed.

Your first dollar of taxable income is taxed at the lowest rate. When your income hits the second tax bracket, THOSE dollars are taxed at that rate, and so on up the income scale ... until you max out. You also have to factor in your deductions to get taxable earnings, finally coming up with your effective tax rate. People often confuse effective tax rate (what you actually pay on all taxable income) with the marginal tax rate (your top tax rate for the last chunk of total taxable income).

Anyhoo. That's the way I understand the whole tax thing.

sksbog
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Re: what is marginal tax rate?

Post by sksbog » Fri Feb 16, 2018 8:17 pm

steve roy wrote:
Fri Feb 16, 2018 7:52 pm
A person's marginal tax rate is the highest rate at which an individual's maximum earnings (the last dollar of taxable income that an individual earns) is taxed.

Your first dollar of taxable income is taxed at the lowest rate. When your income hits the second tax bracket, THOSE dollars are taxed at that rate, and so on up the income scale ... until you max out. You also have to factor in your deductions to get taxable earnings, finally coming up with your effective tax rate. People often confuse effective tax rate (what you actually pay on all taxable income) with the marginal tax rate (your top tax rate for the last chunk of total taxable income).

Anyhoo. That's the way I understand the whole tax thing.
so my marginal tax rate is 28%? if not, how do i find out?

Swimmer
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Re: what is marginal tax rate?

Post by Swimmer » Fri Feb 16, 2018 8:21 pm

Just a thought...seems like it should be called MAXIMUM tax rate rather than MARGINAL. Why marginal?
Seems strange nomenclature.

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Re: what is marginal tax rate?

Post by Swimmer » Fri Feb 16, 2018 8:22 pm

sksbog wrote:
Fri Feb 16, 2018 8:17 pm
steve roy wrote:
Fri Feb 16, 2018 7:52 pm
A person's marginal tax rate is the highest rate at which an individual's maximum earnings (the last dollar of taxable income that an individual earns) is taxed.

Your first dollar of taxable income is taxed at the lowest rate. When your income hits the second tax bracket, THOSE dollars are taxed at that rate, and so on up the income scale ... until you max out. You also have to factor in your deductions to get taxable earnings, finally coming up with your effective tax rate. People often confuse effective tax rate (what you actually pay on all taxable income) with the marginal tax rate (your top tax rate for the last chunk of total taxable income).

Anyhoo. That's the way I understand the whole tax thing.
so my marginal tax rate is 28%? if not, how do i find out?
Yes.

JoinToday
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Re: what is marginal tax rate?

Post by JoinToday » Fri Feb 16, 2018 8:25 pm

sksbog wrote:
Fri Feb 16, 2018 8:17 pm
steve roy wrote:
Fri Feb 16, 2018 7:52 pm
A person's marginal tax rate is the highest rate at which an individual's maximum earnings (the last dollar of taxable income that an individual earns) is taxed.

Your first dollar of taxable income is taxed at the lowest rate. When your income hits the second tax bracket, THOSE dollars are taxed at that rate, and so on up the income scale ... until you max out. You also have to factor in your deductions to get taxable earnings, finally coming up with your effective tax rate. People often confuse effective tax rate (what you actually pay on all taxable income) with the marginal tax rate (your top tax rate for the last chunk of total taxable income).

Anyhoo. That's the way I understand the whole tax thing.
so my marginal tax rate is 28%? if not, how do i find out?
Add (or subtract) $1000 to your income or interest. How much does your tax go up (or down). That will tell you your marginal tax rate. If you tax increases by $280, you are in the 28% bracket

I am in the 25% Fed bracket, 9.3% California. When I start paying AMT, my marginal rate jumps to 41.8% (fed + state). I am hardly in a high income bracket. Nothing chaps my hide more than hearing people say the rich need to pay their fair share. :annoyed
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CppCoder
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Re: what is marginal tax rate?

Post by CppCoder » Fri Feb 16, 2018 9:47 pm

Swimmer wrote:
Fri Feb 16, 2018 8:21 pm
Just a thought...seems like it should be called MAXIMUM tax rate rather than MARGINAL. Why marginal?
Seems strange nomenclature.
It's the tax rate on the marginal dollar, similar in use to how economists talk about the marginal utility and marginal value of things. I would view maximum as being the highest possible (e.g., 37% bracket) tax if I earned infinite dollars, not my highest current rate. Of course, it's language, so there isn't an absolute right and wrong, only what people have collectively decided.

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Re: what is marginal tax rate?

Post by 986racer » Fri Feb 16, 2018 9:54 pm

Swimmer wrote:
Fri Feb 16, 2018 8:21 pm
Just a thought...seems like it should be called MAXIMUM tax rate rather than MARGINAL. Why marginal?
Seems strange nomenclature.
Marginal (in an economic/financial sense) always means the "next" dollar.

Examples, marginal tax rate is the rate you would pay on your next dollar of income. If you were running a business, your marginal expense rate is the amount you would pay to produce your next widget.

It is the difference at the margin.

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grabiner
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Re: what is marginal tax rate?

Post by grabiner » Fri Feb 16, 2018 11:11 pm

The wiki discusses Marginal Tax Rate in some detail. The definition is "the tax rate that will apply to the next marginal – or incremental – amount of income (or deductions). It is calculated by dividing the amount of additional taxes that will be due (or reduced) by the amount of income involved."

For example, if you earn $1000 more, how much more tax will you pay? If the amount is $330, then your marginal tax rate is 33%. (In 2017, this can happen to taxpayers in the 28% tax bracket, if they pay $280 in federal tax and also lose $50 of child tax credit.)
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FiveK
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Re: what is marginal tax rate?

Post by FiveK » Fri Feb 16, 2018 11:44 pm

grabiner wrote:
Fri Feb 16, 2018 11:11 pm
The wiki discusses Marginal Tax Rate in some detail. The definition is "the tax rate that will apply to the next marginal – or incremental – amount of income (or deductions). It is calculated by dividing the amount of additional taxes that will be due (or reduced) by the amount of income involved."

For example, if you earn $1000 more, how much more tax will you pay? If the amount is $330, then your marginal tax rate is 33%. (In 2017, this can happen to taxpayers in the 28% tax bracket, if they pay $280 in federal tax and also lose $50 of child tax credit.)
+1

Note especially the "amount of income involved" part. There is a valid definition of "marginal tax rate" that uses "tax change per $1", but while valid that is practically useless, unless one plans to increase or decrease income by exactly $1.

Also, there can be different marginal rates for different types of income and deductions, even when starting from the same place, due to various credits, phaseouts, and tax rates in the tax code.

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Re: what is marginal tax rate?

Post by HueyLD » Sat Feb 17, 2018 8:55 am

FiveK wrote:
Fri Feb 16, 2018 11:44 pm
grabiner wrote:
Fri Feb 16, 2018 11:11 pm
The wiki discusses Marginal Tax Rate in some detail. The definition is "the tax rate that will apply to the next marginal – or incremental – amount of income (or deductions). It is calculated by dividing the amount of additional taxes that will be due (or reduced) by the amount of income involved."

For example, if you earn $1000 more, how much more tax will you pay? If the amount is $330, then your marginal tax rate is 33%. (In 2017, this can happen to taxpayers in the 28% tax bracket, if they pay $280 in federal tax and also lose $50 of child tax credit.)
+1

Note especially the "amount of income involved" part. There is a valid definition of "marginal tax rate" that uses "tax change per $1", but while valid that is practically useless, unless one plans to increase or decrease income by exactly $1.

Also, there can be different marginal rates for different types of income and deductions, even when starting from the same place, due to various credits, phaseouts, and tax rates in the tax code.
Yes indeed.

In the good (bad) old days, marginal tax rate was relatively easy to define. However, with so many phase-in's, phase-out's, limitations, cliffs, etc., it has become very difficult except for a rough estimate.

That's why it is important to use a tax software or a good spreadsheet to approximate one's marginal tax rate.

bberris
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Re: what is marginal tax rate?

Post by bberris » Sat Feb 17, 2018 8:56 am

Swimmer wrote:
Fri Feb 16, 2018 8:21 pm
Just a thought...seems like it should be called MAXIMUM tax rate rather than MARGINAL. Why marginal?
Seems strange nomenclature.
Because your maximum tax rate may not be the same as the marginal. You may be taxed at a higher rate on your 40,000th dollar than your 60,000th. Look at the wiki for the tax hump.
Last edited by bberris on Sat Feb 17, 2018 11:23 am, edited 1 time in total.

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Toons
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Re: what is marginal tax rate?

Post by Toons » Sat Feb 17, 2018 8:58 am

"One does not accumulate but eliminate. It is not daily increase but daily decrease. The height of cultivation always runs to simplicity" –Bruce Lee

Swimmer
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Re: what is marginal tax rate?

Post by Swimmer » Sat Feb 17, 2018 8:44 pm

Thanks, all, for the explanations. :happy

dbr
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Re: what is marginal tax rate?

Post by dbr » Sun Feb 18, 2018 10:16 am

It may be a useful idea that marginal tax (rate) is a concept applicable to comparing two scenarios. That could include the scenario of adding one more dollar compared to what one had before. It is useful for making decisions between or among alternatives. Effective tax rate is simply a way of expressing the tax cost of a single situation. In either case one it is noted that rates are derived from actual costs compared to income rather than being the cause of the cost. One should think that way because, as another person commented, the structure of the tax computation is so complicated that pure and simple dependence of tax cost on a rate table is very much obscured except in very simple cases.

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Re: what is marginal tax rate?

Post by WhyNotUs » Sun Feb 18, 2018 10:29 am

JoinToday wrote:
Fri Feb 16, 2018 8:25 pm

I am in the 25% Fed bracket, 9.3% California. When I start paying AMT, my marginal rate jumps to 41.8% (fed + state). I am hardly in a high income bracket. Nothing chaps my hide more than hearing people say the rich need to pay their fair share. :annoyed
I know what you mean, I also know that there is a verryyy long list of people that would love to have that annoyance.
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teen persuasion
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Re: what is marginal tax rate?

Post by teen persuasion » Sun Feb 18, 2018 12:12 pm

We have a fun example. We are eligible for EITC with 2 children currently. EITC has a 21% phaseout rate. Before 401k contributions, we'd be in the 10% bracket, plus 4% state income tax bracket. Also, the state matches EITC at 30%. So every $ contributed to traditional 401k saves 10% + 4% in taxes, and increases our refundable credits 21% + 6.3%, for a marginal rate of 41.3%. Ultimately, after retirement contributions and nonrefundable credits like the retirement savers credit, we owe zero tax, and receive a sizable refund due to the refundable credits like EITC, CTC, and AOTC. So our bracket is 0%, but our effective rate is negative.

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tadamsmar
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Re: what is marginal tax rate?

Post by tadamsmar » Sun Feb 18, 2018 12:37 pm

sksbog wrote:
Fri Feb 16, 2018 8:17 pm
steve roy wrote:
Fri Feb 16, 2018 7:52 pm
A person's marginal tax rate is the highest rate at which an individual's maximum earnings (the last dollar of taxable income that an individual earns) is taxed.

Your first dollar of taxable income is taxed at the lowest rate. When your income hits the second tax bracket, THOSE dollars are taxed at that rate, and so on up the income scale ... until you max out. You also have to factor in your deductions to get taxable earnings, finally coming up with your effective tax rate. People often confuse effective tax rate (what you actually pay on all taxable income) with the marginal tax rate (your top tax rate for the last chunk of total taxable income).

Anyhoo. That's the way I understand the whole tax thing.
so my marginal tax rate is 28%? if not, how do i find out?
That probably your marginal rate based on your federal tax bracket.

But state income tax (if any) adds to that rate.

And there are some federal rules can effectively have you ending up paying a different "effective" marginal rate, it can get complicated.

Sometimes you need to take all this into account.

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FrugalProfessor
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Re: what is marginal tax rate?

Post by FrugalProfessor » Mon Feb 19, 2018 11:33 am

teen persuasion wrote:
Sun Feb 18, 2018 12:12 pm
We have a fun example. We are eligible for EITC with 2 children currently. EITC has a 21% phaseout rate. Before 401k contributions, we'd be in the 10% bracket, plus 4% state income tax bracket. Also, the state matches EITC at 30%. So every $ contributed to traditional 401k saves 10% + 4% in taxes, and increases our refundable credits 21% + 6.3%, for a marginal rate of 41.3%. Ultimately, after retirement contributions and nonrefundable credits like the retirement savers credit, we owe zero tax, and receive a sizable refund due to the refundable credits like EITC, CTC, and AOTC. So our bracket is 0%, but our effective rate is negative.
The above answer is great.

Most people misunderstand marginal tax rates. Here's a few definitions that I think are helpful:

Statuatory marginal tax rate: This is the bracket you look up your last dollar earned. Fails to consider phase ins and outs of credits like Teen Persuasion mentions above.

Average tax rate: = total taxes / total income.

Effective marginal tax rate: This is the only tax rate that really matters. And it matters a lot. It is defined as the actual net taxes paid on the last dollar of income earned in a year after accounting for phase ins and outs of credits. It is this number that will help you determine Roth vs Trad decisions. It help you decide how much to work, etc. Unfortunately the most important tax number in your life is not published anywhere. You have to infer it. And it's somewhat difficult to do. Hence my obsession teaching people about it.

I've blogged about it here: https://www.frugalprofessor.com/etic-gu ... rycracker/

I've modeled the effective marginal tax rate in Excel here depending on family size: https://www.frugalprofessor.com/updated-tax-calculator/

Before the tax law change my effective MTR was about 45%, meaning that for every $1 I shoved into a 401k I lowered my taxes by $0.45 that year. The tax law has substantially lowered my effective MTR so I suppose I should update my forum signature accordingly.
I blog. Taxes are the lowest hanging source of alpha.

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Epsilon Delta
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Re: what is marginal tax rate?

Post by Epsilon Delta » Mon Feb 19, 2018 12:23 pm

FrugalProfessor wrote:
Mon Feb 19, 2018 11:33 am

Effective marginal tax rate: This is the only tax rate that really matters. And it matters a lot. It is defined as the actual net taxes paid on the last dollar of income earned in a year after accounting for phase ins and outs of credits. It is this number that will help you determine Roth vs Trad decisions. It help you decide how much to work, etc. Unfortunately the most important tax number in your life is not published anywhere. You have to infer it. And it's somewhat difficult to do. Hence my obsession teaching people about it.
Well it would be the only rate that matters if taxes were continuous and monotonic. However they aren't. For example if you are using the tax tables the tax on an extra $1 of income might be $8, -- a marginal rate of 800%, but the tax on an extra $50 of income is also $8 -- an average marginal rate of 16%. There are enough such things in the code that care is needed when considering marginal rates. You can't just look at the next dollar, some times you need to look at much larger chunks (in the tens of thousands)..

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Re: what is marginal tax rate?

Post by Details » Mon Feb 19, 2018 2:47 pm

Just to show the difference between Maginal and effective, well, and maybe to brag about how low I got my Federal taxes.
2016 I line 22 total income was $105,240, line 37 AGI was $68,226 and line 47 was $39,426. Plus I had college cost credits.
My last $1 was taxed at 15%, the Marginal tax rate. My Effective tax rate was 8/10ths of 1%.
Tax due, $873 / $105,240 = 0.0083 or 0.83%
I did have to pay about $11k in SS taxes, I'm self employed paying both halves. No deductions for that.

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Re: what is marginal tax rate?

Post by triceratop » Mon Feb 19, 2018 2:50 pm

whodidntante wrote:
Fri Feb 16, 2018 7:42 pm
It's the tax rate you paid on the last dollar earned.
Not earned, taxed. According to the IRS I earned $0 last year and yet my federal marginal tax rate was 15%.
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FiveK
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Re: what is marginal tax rate?

Post by FiveK » Mon Feb 19, 2018 3:31 pm

FrugalProfessor wrote:
Mon Feb 19, 2018 11:33 am
Effective marginal tax rate: This is the only tax rate that really matters. And it matters a lot. It is defined as the actual net taxes paid on the last dollar of income earned in a year after accounting for phase ins and outs of credits. It is this number that will help you determine Roth vs Trad decisions. It help you decide how much to work, etc. Unfortunately the most important tax number in your life is not published anywhere. You have to infer it. And it's somewhat difficult to do. Hence my obsession teaching people about it.

I've blogged about it here: https://www.frugalprofessor.com/etic-gu ... rycracker/

I've modeled the effective marginal tax rate in Excel here depending on family size: https://www.frugalprofessor.com/updated-tax-calculator/
Having read those posts, I concur 100% with the spirit of what you are saying. E.g., see charts in Using the marginal rate for investment decisions.

Some quibbles:
- The word "effective" is often used as a synonym for "average", as in (total tax)/(total income). As retiredjg noted in Re: Criteria used to make Roth Conversion decision, "Effective tax rate is not used for much of anything although many people like to know what that number is." Unfortunately, some people have the mistaken idea that traditional accounts are great because one "saves at a marginal rate but pays at an effective rate." It's ironic that your post appears in GCC's blog, as that is one place this mistake is promulgated.

- It's not the "last dollar" that matters, it's "all the dollars affected by" whatever decision is being made. If one's decision involves only $1, then $1 it is. But, e.g., if one is considering what to do for tIRA withdrawals, the SS benefit taxation "hump" may need consideration - see Taxation of Social Security benefits.

"A rose by any other name...": using (change in tax)/(amount of extra income, contribution, etc.) gives the useful rate and, as noted at the top, seems exactly what you are saying. :sharebeer

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Re: what is marginal tax rate?

Post by Sunrise » Sun Mar 11, 2018 9:51 pm

I'm trying to figure out my marginal tax rate also. So in TurboTax for my 2016 return, if I increase my Taxable interest (Form 1040 line 8a) by $1000, my Federal Tax Due increases by $425. Does that mean my marginal tax rate is 42.5%? Is that possible? Thanks.

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Re: what is marginal tax rate?

Post by JBTX » Sun Mar 11, 2018 9:54 pm

Sunrise wrote:
Sun Mar 11, 2018 9:51 pm
I'm trying to figure out my marginal tax rate also. So in TurboTax for my 2016 return, if I increase my Taxable interest (Form 1040 line 8a) by $1000, my Federal Tax Due increases by $425. Does that mean my marginal tax rate is 42.5%? Is that possible? Thanks.
Yes, that would be 42.5% marginal rate. What tax bracket are you in? You may be hitting some deduction or credit phase outs that make the marginal tax rate higher.

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Re: what is marginal tax rate?

Post by Sunrise » Sun Mar 11, 2018 10:10 pm

For 2016 tax year MFJ we were in the 25% tax bracket.

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Re: what is marginal tax rate?

Post by rkhusky » Mon Mar 12, 2018 7:26 am

Sunrise wrote:
Sun Mar 11, 2018 10:10 pm
For 2016 tax year MFJ we were in the 25% tax bracket.
If you are collecting SS, then adding other income can cause some SS income to be taxed that was not previously taxed, which can cause a higher marginal rate. See https://www.bogleheads.org/wiki/Taxatio ... y_benefits

The same holds if one had capital gains that spanned the 15%/25% boundary. Adding other income can cause capital gains that were not previously taxed, to be taxed at 15%. Since the other income is taxed at 15% as well, then the marginal rate would be 30% (holds prior to 2018 across the 15%/25% boundary) .

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Rob54keep
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Re: what is marginal tax rate?

Post by Rob54keep » Mon Mar 12, 2018 9:08 am

It's the tax rate you paid on the last dollar earned.
MFJ both years: 2017 = 25%, Current Estimated 2018 = 22%, No State Income Taxes.

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FiveK
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Re: what is marginal tax rate?

Post by FiveK » Mon Mar 12, 2018 9:37 am

Rob54keep wrote:
Mon Mar 12, 2018 9:08 am
It's the tax rate you paid on the last dollar earned.
That's one definition, but it has the downside of not being useful for financial choices.

A more useful definition is (change in tax)/(amount of money subject to choice) - see Marginal tax rate - Bogleheads for more.

E.g., it's not uncommon for a person to have a 22% marginal tax saving rate on some portion of a 401k contribution, and 12% on another portion. In that situation, the person could decide to do one thing with the amount of money that would save 22%, and something else with the amount that would save 12%.

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