Marginal tax rate

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In the tax system and in economics, the marginal tax rate refers to the change in one's tax obligation as one's taxable income rises:

marginal tax rate = Δ(tax obligation)/Δ(taxable income)

In simple terms, the marginal tax rate is the amount of tax paid on the "last dollar" earned. For an individual, it can be determined by increasing or decreasing the income earned and calculating the change in taxes payable. An individual's tax bracket is the range of income for which a given marginal tax rate applies.

The marginal tax rate may increase or decrease as income increases, although in most countries the tax rate is (in principle) progressive: the income tax rate increases with income to some maximum rate. In such cases, the average tax rate will be lower than the marginal tax rate: an individual may have a marginal tax rate of 45%, but pay average tax of half this amount. In jurisdictions with flat taxes, average and marginal tax rates should be the same.

Marginal tax rate generally refers only to income tax, and hence often ignores sales or consumption taxes; non-taxable forms of income (or different tax rates imposed on different types of income); tax deductions or other tax reductions possible; and various payroll taxes that may be paid by the individual or the employer.

In economics, marginal tax rates are important because they determine incentives to increase income; at high marginal tax rates, the individual has less incentive to earn more. In theory, if a 100% marginal tax rate existed, the individual would no longer have any incentive to increase earnings, potentially even reducing total tax revenue (see Laffer curve). Public discussion of "high taxes" may refer to overall tax rates or marginal taxes.

Marginal tax rates can be measured either by looking at published tax tables (to get the official marginal tax rate) or by looking at actual practice, i.e., how an increase in income changes tax obligations either within "brackets" or between them, including all types of taxes or just some of them. It may be calculated noting how tax changes with changes in pre-tax income, rather than with taxable income.

Marginal tax rates do not fully describe the impact of taxation. A flat rate poll tax has a marginal rate of zero, while a discontinuity in tax paid can lead to positively or negatively infinite marginal rates at particular points.

Where social security and other benefits are related to income, the combined tax and benefit effect can also be taken into account giving a result sometimes described as the marginal effective tax rate or the marginal deduction rate. If the marginal deduction rate exceeds 100%, then an increase in gross income leads to a decrease in disposable income, discouraging attempts to increase income; when this occurs for low income individuals, it is known as the "poverty trap".