Marginal tax rate

A marginal tax rate is the tax rate that applies to the last dollar of the tax base (taxable income or spending), and often applied to the change in one's tax obligation as income rises. An individual's tax bracket is the range of income for which a given marginal tax rate applies.

The rate also indicates how much tax you would save on each dollar of income that does not need to be reported on your tax return.

Marginal tax rates do not fully describe the impact of taxation. A tax is progressive if marginal rates increase with the tax base, and regressive if marginal rates decrease. In the US, income taxes are progressive, and thus the fraction of your income that you pay in taxes is less than your marginal tax rate.

Calculation
To calculate a marginal income tax rate, consider how much additional tax you would owe if you added $1 to your income. For example, if your federal tax bracket is 25%, your state tax bracket is 8%, and you do not itemize deductions, an extra $1 of income would cause you to pay 8 cents in state tax and 25 cents in federal tax, so your marginal rate is 33%. If you do itemize, the 8 cents in state taxes mean that you pay federal tax on only 92 cents, which is 23 cents of federal tax and a marginal rate of 31%.

The actual marginal rate can be complicated if your taxes include credits, deductions, and exemptions which are phased out with income; if you are nominally in the 25% bracket but you lose $5 in tax credits for every additional $100 you earn, your marginal rate is actually 30%.

In particular, taxation of Social Security benefits causes many moderate-income retirees to be subject to a much higher marginal tax rate than their tax bracket. If you are in the range in which Social Security becomes taxable, each additional $1 of income causes an extra 50 or 85 cents of Social Security to be taxable at the same tax rate, until 85% of the whole benefit is taxable. If you are in the 15% bracket and each $1 causes an extra 85 cents to be taxable, that extra $1 of income increases your taxable income by $1.85, with 27.75 cents due in tax giving you a marginal tax rate of 27.75%. If you are in the 25% bracket and each $1 causes 85 cents to be taxable, your marginal tax rate is 46.25%.

If you use tax software, you can compute your actual marginal rate by adding $1000 to your income and looking at the change in your tax bill; you may need to make a small adjustment for the deductibility of state taxes, as a higher state tax this year will give you a federal tax deduction next year.

Using the marginal rate for investment decisions
The marginal tax rate determines the relative after-tax value of different investments. If your marginal federal tax rate is 25%, then a corporate bond fund with a 4% yield and a municipal bond fund with a 3% yield have the same after-tax value to you.

Marginal Rate of Zero
A tax with a marginal rate of zero is a fixed-amount tax, such as a tax of $100 on every house rather than a percentage of the value of the house.

Flat Rate Tax
A flat rate tax has a constant marginal tax rate. Sales taxes and property taxes are normally flat, a fixed percentage of the value. Income taxes in some states are almost flat; typically, there is a fixed amount (such as a standard deduction) which is exempt from tax, and everyone making more than that fixed amount pays the same marginal tax rate, so the average tax rate varies.