After the past week’s posts about the fiscal cliff and how it will affect you, I thought a post about the difference between your marginal tax rate and your average tax rate would be appropriate. It will be easier to follow this post if you simply watch the video, but I’ve included a brief summary below.
The United States’s tax system is progressive.
Basically, this means as your income increases, your income will fall into higher and higher marginal tax brackets. Marginal tax is the tax you will pay on your next dollar of income. If your next dollar of income falls within the 35% tax bracket, the tax rate that you pay on the next dollar of your earnings is 35%. So, the part of your income that falls within each tax bracket is taxed at the rate specified for that tax bracket.
Average tax is the taxes you have paid divided by your total income.
Therefore, your average percentage of your income you pay in taxes will almost always be less than the marginal tax rate of the tax bracket your income falls within.
It’s easier to describe this in video format, so watch the video below for a more thorough explanation.
Unfortunately I had to remove the video, but I’m working on an updated version which should be up by the end of July 2014.