How Do Tax Brackets Actually Work?
- Articles, Blog

How Do Tax Brackets Actually Work?


There are a few topics that are considered
off-limits at my family’s Thanksgiving table, and one of them is TAXES, or more specifically,
the American tax SYSTEM. Virtually everyone has a strong opinion about
it: It’s unfair! It doesn’t go far enough! It’s too complicated! Cable news and social media are filled with
passionate debates about it, but how many people actually know how our current tax system
works? If your eyes glaze over when you hear phrases
like “progressive taxation” and “marginal brackets,” you’re not alone. Even some of our law-makers seem to have a
shaky grip on the concept. But if you hope to have a say in a system
that impacts your wallet every day, you should understand how—and why—it ended up this
way. Let’s start with something all of us can
agree on. The U.S. tax code is complicated. Really complicated. It’s one of the most complicated systems
in the world, taking the average citizen 13 hours to file each year. Compare that to, say, Japan, where it’s
closer to 15 minutes. And one reason we have such a confusing system
is because our income is taxed at different rates, depending on how much we earn. For nearly 100 years, our country had no income
tax. The first one was levied in 1861 during the
civil war at a flat 3% tax on income over $800.The next year, in 1862, the first “progressive
tax bracket” appeared, with the 3% rate AND a 5% rate for any income earned over $10,000. Then in 1872, the income tax was repealed
because — get this — the government no longer needed the money. Can you even imagine…? Then in 1913 with the 16th Amendment, progressive
taxes made a permanent come-back. It gave the Federal government the free reign
to tax workers’ income in every state. So what is a “progressive tax”? Well, you can think of tax systems coming
in one of three main flavors. Regressive, Proportional, or Progressive. A regressive tax impacts lower paid workers
more severely. Paying sales tax on groceries or clothing
will end up being a higher portion of a low-earner’s pay check than a high-earner. A worker earning $20,000 a year who pays $1,000
in sales tax will be parting with 5% of his income. Another making $100,000 paying that same tax
for the same goods will only be charged 1% of her income for the same thing. A simpler solution would be a proportional
tax, where, simply put, everybody pays the same percentage of their income, no matter
how much they make. Nine states currently impose a proportional, flat state income tax. That means no matter how much you make, your
tax rate stays the same. For example, 5% of every dollar earned. Finally there’s the progressive tax, a system
that has a heavier impact on high earners. Low earners may end up paying little or nothing,
with only the wealthiest people paying the highest tax rates. How does this actually work? Through a series of different tax levels or
“marginal tax brackets”. Buckle up, it’s about to get exciting! Let’s say you’re a single person making
$60,000/yr. A quick look at the IRS Tax Brackets will
tell you that you fall into the 22% bracket. Do you have to give the government 22% of
your income? No! A common misconception is that entering a
higher tax bracket means your whole income is taxed at the higher rate. So how much are you actually paying? After taking your available deductions, you’re
left with $47,800 in “Taxable income”. As of 2019 we have 7 marginal tax brackets
between 10 and 37%. Each bracket along the way applies to one
specific chunk of your income, not the whole thing. Bracket 1 is for your first $9,525, and it
gets taxed at 10%. Next stop is Bracket 2. This applies to $29,175, and is taxed at a
rate of 12%. Last stop is Bracket 3, where your remaining
income of $9,100 will be taxed at 22%. Even though you’re in the 22% tax bracket,
your “effective tax rate” is only 10%, thanks to the marginal rates in our progressive
tax system. So a single-filer with a taxable income of
$500,001 may be in the highest tax-bracket of 37%, but only $1.00 is taxed at that rate. The effective rate will be much lower. This system is definitely more complicated
than a flat-tax. But is it fair? Simply put; no. A progressive tax system, by definition is
unfair. It allows lower earners to pay very little
tax… In fact more than 44% of Americans pay no
federal income taxes. And the more money you make, the less of it
you will keep. Opponents of progressive taxation tend to
be higher earners, arguing that the system “punishes” wealthy people, and actively
discourages making a higher income. They claim that a flat-tax would be simpler,
easier, and more fair. Supporters of a progressive tax, however,
point to the real-world human impact on struggling families and low wage earners. They argue that if people have a greater ability
to pay, then they should pay more. And a progressive tax system, they claim,
can counteract the regressive nature of sales taxes, easing the impact of taxes on your
rent or groceries, while hitting you harder in your ability to take vacations or buy luxury
goods. And while nobody loves paying taxes, the average
US tax-payer actually pays less than almost any other developed nation. Compared to, say Belgium, we get off pretty
easy. Their lowest tax-bracket is 25%, and the highest
is 50% for anything over 38,080 Euros! Do you feel our progressive tax-system encourages
laziness? Does it discourage people from earning more
money? Or is it giving a leg-up to people with lower
salaries? Whatever your opinion, now that you understand
the mechanics of marginal brackets and progressive taxation, you’ll be in a much better place
to argue about it over your next Thanksgiving dinner. Or in the comments section. And that’s our two cents! Thanks to our patrons for keeping Two Cents financially healthy. Click the link the description if you’d like to support us on Patreon. I’m sure you have an opinion about our current
tax system, go ahead and put it in the comments, or you could share it with your elected representative!

About Ralph Robinson

Read All Posts By Ralph Robinson

100 thoughts on “How Do Tax Brackets Actually Work?

  1. How exactly is this taxation system unfair? It's 100% fair because everyone pays the same percentage on the equivalent amounts of their income. It's like saying that it's unfair that when people eat more they poop more.

  2. I live in one of the states that have a proportional state income tax. It seems more fair to me and works well for the state. It’s much easier to figure out taxes. I’m in favor of the proportional tax rate.

  3. progressive system does only one thing – incentivizes people to find a good loopholes in tax system. watch pretty much any video with "how I pay almost no taxes on my 6-figure income" to see what I mean

  4. Other tax details few people are aware of, in increasing order of how much you'll be ticked off …

    Our tax rates aren't fully progressive due to payroll taxes. At about $133k, the effective tax rate drops by 6.2% since social security payroll taxes aren't charged on income above $133k. Payroll taxes weren't shown in the tax brackets presented in the video, but they should have been included to highlight this issue and highlight that the actual tax rate of someone making $60k is really about $18%, not 10.7%.

    Investment returns, which is how most of the uber rich make most of their money, are taxed at a lower rate than what many people pay for income they get for, ya know, working. Additionally, investment income is not subject to payroll taxes, so think of investment income as getting an automatic 6.2% social security + 1.45% Medicare = 7.65% tax break. So the lesson: be rich, sit on your but, and make tons of money.

    Real estate loopholes are where the real savings lie. If you own a property and charge rent, that rent is income, but the property "depreciates" at a substantial rate, meaning the property owner can often write off most if not all of the rental income due to this depreciation. That is, if I buy a $300k property and charge $2000 per month in rent, I make $24k — but I'm not taxed on $24k. Instead, I get to subtract my mortgage interest (probably ~$10k) as well as up to 3.6% of the property value for the first ~27 years of ownership (so about $11k each year), which means … for my $24k in income, I'm taxed on $3k.

    Real estate, part 2. Yeah yeah, but the property owner will be eventually taxed, right? Not necessarily. While the owner could deduct "depreciation" from the income for the property, that property was actually appreciating in value. So let's say they sell the property after 15 years for $500k. At that point, they would be taxed on the $200k profit from the sale plus about $175k in "depreciation" that they used in tax offsets. But they probably won't. If they reinvest that $375k back into another property within a couple months, they call it a "wash" sale and postpone paying those taxes until they sell that newly purchased property. And guess what … they can keep doing this indefinitely. These special real estate loopholes allow property owners to avoid paying almost any taxes ever on their income. They defer forever.

    So you might be guessing: these super rich real estate tycoons' property is finally taxed at death, right? LOL, you are way too optimistic! When someone dies, their estate doesn't pay capital gains / investment taxes. They are effectively forgiven. CURRENTLY the people who inherit the property will be taxed if their inheritance is more than $11.4 million (per person). Oh, and it's of course easy for them to lowball the actual value of the property to also dodge this tax ("that $40m apartment building? uh… I think it's worth $10 million. oh, that means I don't have to pay any tax? how convenient!").

    But at least those estate taxes are here to stay, right? For real, where do you get this optimism??? Republicans have dubbed the estate tax the "death tax" as a way to market it as something evil. They've been trying to repeal the estate tax for decades. If they're successful, then families running real estate businesses can defer taxes forever, and pass their millions, or even billions, of dollars in property down through the family without ever with an effective tax rate of perhaps 3-5%.

    Have I ruined your day?

  5. There is no way tax margins will ever go flat rate. The govt likes the revenue. If you are truly rich, the capital gains and lobbying is how you save money.

  6. I'd rather have higher taxes if it meant that everybody would have access to better education, free healthcare, etc. I'd rather be taxed more if it meant the collective happiness of my country would be higher. When you look at countries that do get taxed more, they are, in general, happier overall because those taxes go in to paying for higher education, healthcare, schools, childcare, etc.

  7. Great video! The complexity comes from having non-standard taxes, for the most part. If all you did was work as an employee and file with your W2s, it would be simple. It gets WAY more complex when you add anything like:
    -Working for yourself (if you earn more than $400 doing something on the side, you have to file that in as self-employed income)
    -Investments of any kind
    -Living/working abroad
    -Benefits of any kind
    -Deductions of any kind

    …or any other non-standard circumstances. It takes me hours to do my taxes each year, because I need to make sure I'm filling out all the paperwork correctly and submitting everything necessary for my specific circumstances.

    This video is a great primer to the US tax system, and I especially like how you hit on the fact that tax brackets are marginal. That's an important point to understand.

  8. Your video pushes two commonly repeated myths about taxes. Which is sad given you seek to debunk financial myths. You also missed some very related points.
    Myth 1) Sales taxes are regressive.
    This assumes that the poor & rich spend the same, which simply isn’t true. Investigations into spending show the rich spend proportionally more on goods & services. They buy more & more expensive items. Now the effect does decay at the highest incomes. But the general effect is far more proportional than activists like to admit. The disparity gets even greater when one considers how much subsidized income low income people get from government programs.

    Related two big reasons for sales taxes are they encourage saving & they allow individuals control over their tax bill. Want to pay less in taxes? Spend less & save more. It’s one of the most fair taxation systems there is.

    Myth 2) Americans have a low tax level. While federal taxes are lower than other national taxes, state & local taxes are higher. Studies put the average American’s cumulative lifetime tax burden at 54% of their income.

    It would also have been good to educate your viewers on how the country used to raise funds; through the head tax.

    Also that as marginal rates change over time the revenue to GDP ratio stays the same.

  9. Progressive tax is not "fair" but it is more humane. Like mentioned in the video, the tax money taken from the poor is going to be used for essentials. Food, rent, every dollar counts. Once you get to a certain income, your taxes are from your luxury car money. It's not fair, but neither is capitalism.

  10. Your Belgium reference was slightly on the nose – they also have socialised medicine and better standard of living then most people in the US so…

    There is a good reason to pay higher taxes. The government may take more, but you also, hopefully, get more in return.

  11. Most other "western" countries have tax brackets. The US system is just overly complicated for no real reason. It takes about 30 minutes to do Australian tax returns if not complicated and only a few deductions as the whole form is populated for you. It doesn't have to be hard, the US just chooses to let the free market decide, which has made it more complicated. Tax systems and returns shouldn't be left up to companies who sell programs to make it easier or accountants who charge you, it's a serious conflict of interest.

  12. How is progressive tax unfair to high earners?? In your own example a person on $60k a year pays 10.74% tax which is practically the same as a person on $9,525 would pay (10%)! If anything, it benefits the high earners because their remaining 90% are A LOT more than 90% of someone who's in the bottom bracket (under $9,525). If anything these tax brackets for the high earners are not high enough…

  13. I think the issue comes down also to where this income tax money goes. For instance, if the government funnels income tax money back into the public sector such as in education and transportation, then one could make the case for a flat rate as although it hurts less well off people in the short run, they get that money back through government services that rich people may not always use, ex; bus services. Without naming names, spending tax payer money to squabble about archaic and misogynistic policies is part of the problem why people prefer progressive tax rates. Just let me get by and feed myself and do the bickering with the rich people's money

  14. I’m Irish, so I’ll stay out of the American debate… But here, we only have 2 brackets. 20% on the first €35,000 and 40% on everything above.

    I’m earning just above 35k, so while it does suck to have nearly half of any pay increase gone in taxes, I’m fully aware of the growing problem of income inequality so I’m kinda understanding & accepting of it 🤷‍♂️

  15. Anyone that thinks a progressive tax system doesnt go far enough, is either ignorant to how it works or mathematically ignorant.

  16. In the government's point of view, it is probably less about being fair and more about how much they can squeeze out of every tax payer without upsetting them.
    That said, it is true USA tax rate for middle class income earners are lower than most (if not all) developed countries.
    It is also true that the filling tax, at least for me, is a very lengthy process. Takes me a few weekends to complete.
    I'm sure you're gonna cover this soon. Tax deduction. USA has many good areas to deduct tax, it is actually very friendly to wealthy people or should I say people in pursuit to be wealthy.

  17. Haha I live in a developing country with a higher income taxation tab US and without brackets, so in theory I should pay more than you. However here we don't have rule of law, so didn't pay anything hahahaha

  18. GREAT VIDEO GUYS | Yes, our tax system is complicated, but that’s partly due to the government wanting to push or incentivize certain types of activities such as rental properties, self-employed businesses, depreciating assets, etc. BUT we do end up taxing higher earners a lot more than we tax lower-income earners when factoring in deductions. VERY SIMPLE AND GOOD EXPLANATION! 😎👍🏻

  19. Simplicity is the best considering how Japan does its taxes.

    I wish there is a reverse tax filing like Japan where the government just sends your income tax like a bill on which you can claim deductions accordingly rather than going through accountants and making various checks and balances yourself to be checked by govt who already have all the relevant details.

    I can be wrong so please correct me.

  20. I would be for a percentage flat tax if it wasnt for the fact that politicians from both sides have given special groups ways to avoid huge amounts

  21. I still can't believe how many people don't understand the math behind the progressive tax system and sincerely believe that being in certain tax bracket means you'll pay that tax rate on ALL of your income.

  22. Haveing a better paying job and have more financial secruity is something I'd jump at even if the taxes are higher. Being low income is incredibly stressful. Infact I am working to try to get a better job now. Its so awful having to constantly worry about food,rent,clothes, just basic needs.

  23. The problem isn’t the income tax, it’s corporate taxes. Corporations worth billions of dollars routinely single digit or no taxes each year.

    Absolutely insane.

  24. This is an important video. I hate it when people say "why would I want to be rich if I'm taxed at 70% and I really don't get to keep anything?" Yeah, they have no idea that only a portion of their income would be taxed at the highest rate.

    I support a progressive tax system because, it might not be fair, but it's just. Nobody truly needs more than a 1/4 million dollars per year, do they? Not really. Taxing everything above that at 70% or even 90% doesn't spur laziness. Why would anyone just give up making more when they hit six figures just because they will be taxed slightly more? I'm no psychologist, but I don't see anybody voluntarily making less than $9,000 per year just to be taxed as little as possible. I myself would rather make $100,000 taxed at 50% than $9,000 taxed at 10%. You know why? Because keeping $50,000 is better than keeping $8100, even if I was taxed more.

  25. If you pay taxes, those 44% who don’t are living on the fruits of your labor.

    Before anyone starts assuming things, I mean you’re being exploited even if you only pay $1. And that’s equally true of the mega corporations who pay nothing but gain benefits from taxes paid by small business.

    Social Security (the great Ponzi scheme that will fun dry well before I retire), corporate welfare (incentives to Amazon who pay $0), Bailouts, abuses of welfare, those working under the table, those feigning disabilities…

  26. We have a progressive tax rate and stil nobody is trying to earn less. Actually we are the country where people makes more money. A CEO in a Usa corporation makes 100x times the average worker payroll of that corporation. In other countries the CEO's makes less than 20x times the average worker payroll. That's why we have dudes like Jeff Bezos in Amazon with a 150 billions in personal wealth or Facebook, or Microsoft,Koch Brothers, etc. We have probably the most wealthiest people in the world.

  27. From watching the video, I know which system you prefer. You didn't do a good job of presenting the "regressive" tax system. You should invite someone who supports it to give it equal time to the "progressive" system.

  28. I may say that while the system has high income earners pay more than their lower income counterparts, they don't seem to be suffering much what with all those expensive luxury/performance vehicles, yachts, jewelry, exotic vacations and mansions they continue to buy up. Yeah, they got cash to spare alright….after taxes and pay tax professionals to help squrrel-away the rest of their surplus income in off-shore shelters.

  29. Warren Buffets secretary would be pleased to know Amerika has a Progressive (as opposed to a REGRESSIVE) Tax System! Same for Jeff Bezos/Amazon!

  30. I don't think it encourages laziness but I think it's wrong to expect half the country to pay for the other half. If you pay nothing you care nothing and you should have no say in how things are run.

  31. The rich don't pay taxes. They just create a company and filter all their money through that. They buy things in the company name to make it look like they're breaking even each year. In reality, they're just acquiring assets with any leftover cash to make themselves even richer rather than giving it to the government. Even still though you pay a much higher rate of tax as an employee than you do as a business owner or investor.

  32. That Belgian tax… you forgot to include commune tax in it xD in Brussels that is another 8%.

    To be fair Belgium is extreme example of taxation…

  33. & the left wants to tax wealthy people more? Lol. Then no one will want to put the work in to be wealthy because it will be taken away anyways!

  34. Can you guys please do a video on credit card billing cycles, and advice on how you would use a credit card responsibly in general.

  35. That’s why I’m in favor of flat out rate. I’m current am making a couple of thousands of dollars, and if my blog keeps going the rate that it is I can easily about hundreds of thousands of dollars, but in doing so I will take a hit due to the progressive tax rate. I personally dislike AOC 70% rate for over $10,000. Most millionaire work their asses off and I don’t think it’s fair for people who took risk and now have a better life. I feel the mentality of taxing the rich more makes lower earned feel entitle and complain instead of climbing out of poverty. And I’m not even a Republican before people start commenting. I’m actually a Democrat and I can’t stand “Democratic Socialist” like AOC, or Sanders.

  36. Honestly, all I want is for my tax dollars to stop funding wars and killing people overseas. I would rather they go towards education and protecting the environment.

  37. Progressive taxation is definitely the best way to go. Now, we have to get the ultra wealthy that uses the loop holes to commit tax evasion. Now that is unfair to the wealthy people paying high taxes.

  38. I have mixed feelings about this video. On the one hand, it really does seem like almost everyone in the U.S. somehow misunderstands what a marginal tax bracket actually is, so it's really important to debunk that misconception. On the other hand, it's a fairly simple concept to grasp, and you could still file your tax return in 15 minutes if that were the only complication. The real fun starts when you start talking about deductions, credits, different classes of income, what options you even have to file, etc.

    And Trump was musing last week about indexing capital gains to inflation. What a regressive, system-complicating tax cut that would've been!

  39. How about we abolish our current system and just do a simple flat tax? 5% will hurt you just as much if you make $35,000 a year or you make $350,000 a year.

  40. Everyone else: "x% on the wealthiest y% is fair/too much/not enough!"
    Me: "Are politicians so stupid they can't write a continuous function? Why do they need to use brackets?"

  41. I've never been particularly fond of the progressional tax brackets, due to the fact that taxes have a tendency to throw off your math quite a bit, and, at least on the federal level, if you mess up on it, the IRS will drop by.

    Now, I've never had the IRS show up, but, I also work in a company that pulls the taxes out first. But the multiple brackets, I feel, are simply problematic due to the many things that any group/person must attempt to keep track of.

    My thought is that we have the flat, proportional tax rate. Keep this at 10%, regardless of whether it's a person, company, etc. This would allow the government to get a ton of money (potentially more so than they're getting now if done right), and keeps everyone from being horribly overwhelmed with tax math.

    If necessary, of course, dropping it entirely below a certain amount would be quite beneficial as well.
    The idea is that, the government will be able to get $100 from the guy who makes $1k in a week, but, be able to make $100m off of a $1b company like Apple, etc.

    People earning more, will still pay more under the proportional tax rate. And, to be perfectly honest, the progressive system is simply punishing people for being successful.

    I mean, it's effectively rewarding those who are unable to significantly add to the economy, but punishing those who succeed, and as a result, it's bringing the entire economy down a lot. Reducing taxes and establishing the proportional system will encourage everyone to want to be extremely successful, and as a result, our economy will flourish and prosper. This in turn would promptly result in everyone becoming even richer/wealthier over time as everyone will be able to keep more of their money to be able to spend it on other things. It's a very beneficial system with, honestly, no drawbacks.

    As for these people and corporations that would build more wealth at the expense of their workers: simply put, those are corrupt. Not all of them will mistreat their workers, and as a result, they'll pay more and help their workers.

  42. What I don't about the progressive tax is that its an automatic increase in tax over time when you take into account inflation. All the government has to do is not adjust the brackets.

    Fair point about offsetting the regressive taxes but I would prefer minimisng regressive taxes. I would also prefer a flat tax with UBI over the progressive tax.

  43. There will always be people with lower salaries no matter how much encouragement is given and no matter what we need someone to take those jobs so in a more realistic prospective a progressive taxation is fair because other wise people at lower incomes wouldn’t keep much of their income making them even more dependent on government handouts

  44. The progressive tax system would be easier for Americans if Free File was allowed. The IRS already has the info we have to input every year. So basically all they would have to do is send us a bill to look over and for the tax payer to add any extra deductions and credits for the year. BTW, this system already exists, but Intuit gives a lot of money to Congress in campaign contributions to keep them for voting on it.

  45. other countries like in europe pays more tax but they get benefits such as free education, health, and other things that we as americans pay a lot for. that said that tax here should encourage people to earn more, but at the same time have companies pay there workers better as they get tax cuts.

  46. Vote for me, not old enough yet but when I am, I'll take the whole income earning Americans at a 2% flat rate, no questions asked.
    👇 Turn this blue if you'll vote for me!!

  47. We would not have this confusing problem if we got rid of income taxes.

    ✊ Abolish the 16th Amendment NOW!

  48. Off topic, but you should definitely do a video on financial aid for college. Including the different kinds of loans and work study programs.

  49. Name one country that ever significantly improved its quality of life when it decided to significantly raise taxes

  50. In Finland the government already knows how much people earn and some of their deductibles, and just sends a paper that gives the percentages to employers so that they can deduce the taxes from the salary. And government automatically fixes the errors later either doling out some back taxes or tax returns. So on average people don't really spend time filing taxes, with our progressive tax system. However the filings of employers do still complicate things.
    My favorite system would be flat tax combined with basic income, if it would be politically stable. The Basic income would replace the welfare programs and tax progression. The basic income and extra taxes for low earners would cancel each other out, while having very simple system would save everyone's time. And having basic income would just eliminate need for bureaucratic work dealing with welfare programs.
    If percentage is the same employer can just give government a fixed percentage of paid salaries and not to worry about anything else. So less unproductive busywork for both taxes and welfare, while people get similar amounts compared today.

  51. In my opinion I would rather have a set rate percentage tax. I have middle income parents where they can’t even use their taxes for government programs. We don’t get FASFA, medical care insurance, Tuition Assistance etc. Yet, the government says if I get pregnant and have a lot of children under 24 I can qualify as a independent. I do know people who take advantage of the system. I want to know how I can prepare myself with knowing what is a Tax Credit and Tax Deductible. There are others in saying their are loopholes which I want to learn.

  52. You missed what is, in my opinion, the most persuasive argument in favor of progressive taxation. Taxes contribute to the general stability of the government. The wealthy have much more incentive to want a stable government. Consider the millionaire business owner vs the dude making $15 an hour. If the federal government suddenly collapsed, the life of the dude making 30 grand a year ago can't get much worse. The millionaire might lose his business. Put simply the more you have, the more you have go lose and you should therefore pay higher taxes.

  53. I'm supposed to bring home 2k bi-weekly but instead I bring home 500+ less than that, that's taxes for yah 🤦🏾‍♀️🤦🏾‍♀️🤦🏾‍♀️🤦🏾‍♀️🤦🏾‍♀️

  54. I'll pay more taxes if everyone in the US gets free health care. And yes, I know it's not "free" if I'm paying for it in taxes, but I want this.

  55. I don’t understand the regressive and proportional tax explanations? I think they could have been better explained, but good video!

  56. 1913? Hmm what a coincidence that was the same year the fed was created
    Yea for sure just a coincidence……..

    END THE FED!

  57. Considering the government caters to the wealthy it's perfectly fair they pay more. Benefit to the poor is merely incidental.

Leave a Reply

Your email address will not be published. Required fields are marked *