Progressive tax

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A Progressive tax progressively takes a larger percentage of income from higher-income groups than from lower-income groups and is based on the concept of ability to pay. A progressive tax system might, for example, tax low-income taxpayers at 10 percent, middle-income taxpayers at 15 percent and high-income taxpayers at 30 percent. The U.S. federal income tax is based on the progressive tax system.[1][note 1]

Taxable income

Before looking at how this works in the U.S. income tax system, the concept of "taxable income" needs to be understood.

You can receive income in the form of money, property, or services. In most cases, an amount included in your income is taxable unless it is specifically exempted by law.[2]

Taxable income is your gross income minus the deductions described in 26 U.S.C. Section 63.[3]

Income that is taxable must be reported on your return and is subject to tax. Income that is nontaxable may have to be shown on your tax return but isn’t taxable.[2]

Tax rate increases as taxable income increases

This table shows how to calculate taxes to be paid on taxable income by a single person in 2018.

2018 Federal Tax Rate, Single Person[4]
Taxable Income Tax Rate Tax Bracket
$0 - $9,525 10% of Taxable income 10%
$9,526 - $38,700 $952.50 plus 12% of the amount over $9,525 12%
$38,701 - $82,500 $4,453.50 plus 22% of the amount over $38,700 22%
$82,501 - $157,500 $14,089.50 plus 24% of the amount over $82,500 24%
$157,501 - $200,000 $32,089.50 plus 32% of the amount over $157,500 32%
$200,001 - $500,000 $45,689.50 plus 35% of the amount over $200,000 35%
$500,001 or more $150,689.50 plus 37% of the amount over $500,000 37%

As Taxable income increases, the amount of tax paid on each additional dollar increases (see Marginal rate below). This is the progressive aspect of the tax - higher income means possibly paying more tax on that additional portion of income. A proportional or flat tax would apply the same percentage regardless of income.

The figure below is a graphical representation of the tax table.

Income tax table.png

Tax bracket

A tax bracket is the range of taxable income to which a tax rate applies.[5] In this example, there are seven ranges of taxable income. Each range is taxed at a different rate and is therefore a separate tax bracket. The tax brackets in the above table are 10%, 12%, 22%, 24%, 32%, 35%, and 37%. (The tax bracket column is not present in the actual IRS table. It was added here to show the concept.)

Marginal rate

Main article: Marginal tax rate

Within each tax bracket, each additional dollar will impose the same amount of tax. For example, you will pay a tax of 10% if your income is $5,000 ($500 tax) or $9,000 ($900 tax).

If your Taxable income increases to $10,000, your next dollar of Taxable income is taxed at a 12% rate. This is a higher marginal rate than the 10% rate imposed for $9,000.

The marginal rate is not the total tax you pay. It only describes the rate of the tax paid for that specific amount of Taxable income.

Calculation of the income tax

IRS instructions require use of the tax tables, which provide the tax directly from your income, when taxable income is less than $100,000. No calculations are required. The following example is for illustrative purposes to show how the tax schedules work.[6]

A single person has a Taxable income of $60,000 which falls within the 22% tax bracket.

The approach is to add the amount of each underlying tax bracket up to the total Taxable income and is shown graphically in the figure below.

Income tax example.png

For convenience, the IRS places the sum of the underlying tax brackets in the same row as the Taxable income. The amount of $4,453.50 is the sum of the 10% and 12% brackets ($3,501.00 + $952.50).

2018 Federal Tax Rate, Single Person (from above)
Taxable Income Tax Rate Tax Bracket
$38,701 - $82,500 $4,453.50 plus 22% of the amount over $38,700 22%

The manual calculation and IRS schedule results are identical ($9,139.50).

A misconception about progressive tax

A common misconception is that changing your tax bracket implies that your entire income is taxed at that rate.[7]

As demonstrated in the previous example, you are only taxed at the marginal rate for the amount of income which applies to that tax bracket.

This is much lower than incorrectly calculating a tax of $13,200 (22% * $60,000) on the entire income at the 22% marginal rate.

Notes

  1. This is in contrast to a proportional or flat tax that takes the same percentage of income from all income groups. Definition: Understanding Taxes - Glossary, IRS.

See also

References

  1. "Understanding Taxes (Student)". Internal Revenue Service. https://apps.irs.gov/app/understandingTaxes/student/whys_thm03_les03.jsp. Retrieved November 26, 2018.
  2. 2.0 2.1 "Publication 525, Taxable and Nontaxable Income". Internal Revenue Service. https://www.irs.gov/publications/p525. Retrieved December 01, 2018.
  3. "[USC03] 26 USC 63: Taxable income defined". Office of the Law Revision Counsel of the United States House of Representatives. http://uscode.house.gov/view.xhtml?req=granuleid:USC-prelim-title26-section63&num=0&edition=prelim. Retrieved December 01, 2018.
  4. "2018 Federal Tax Rates, Personal Exemptions, & Standard Deductions". Internal Revenue Service. https://www.irs.com/articles/2018-federal-tax-rates-personal-exemptions-and-standard-deductions. Retrieved November 26, 2018. The tax bracket column has been added for the wiki.
  5. "What Are the Tax Brackets?". H&R Block. https://www.hrblock.com/tax-center/irs/tax-brackets-and-rates/what-are-the-tax-brackets/. Retrieved November 25, 2018.
  6. Bogleheads® forum post: Re: Wiki - Progressive tax, HueyLD. Nov 29, 2018
  7. Bogleheads® forum post: Re: How do tax brackets work?, Glockenspiel. Nov 26, 2018

External links