What is a Marginal Tax Rate? - Definition & History

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  • 0:00 Marginal Tax Rate
  • 0:56 U.S. Marginal Tax…
  • 3:14 Calculating Tax Liabilities
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Instructor: Dr. Douglas Hawks

Douglas has two master's degrees (MPA & MBA) and a PhD in Higher Education Administration.

Most Western countries use tax brackets and marginal tax rates as the basis of their tax code. In this lesson, you'll learn the definition of marginal tax rate and its history in the United States.

Marginal Tax Rate

A marginal tax rate is the rate at which your next incremental dollar in taxable earnings is taxed. Marginal tax rates are used when a tax system uses brackets to define different tax rates for different levels of income. The United States has this type of tax system and because there are only seven tax brackets, we can use the 2013 U.S. marginal tax rates, as seen below, in our examples.

Figure 1. 2013 Marginal Tax Rates

Using tax brackets is a popular method of determining tax rates because most governments, and most people, believe that it isn't fair to expect all citizens to pay the same percentage of their income in taxes. If the flat rate was 10%, someone that made $10 million would pay $1 million in taxes, while someone that made $10,000 a year would pay $1,000. That $1,000 is a lot more important to the person making $10,000 than the $1 million is to the person making $10 million.

U.S. Marginal Tax Rates History

There's a saying that states, 'Only two things in life are certain: death and taxes.' Technically, that's not true. The U.S. didn't have personal income tax before the Civil War. In 1861, a temporary tax to help fund the Civil War was passed. There were two brackets in that plan: below $800 per year and above $800 per year. For those making below $800 per year, there was no tax, and for those making above $800 per year, the tax rate was 3% on all income over $800.

After the Civil War, the personal income tax was dropped, at least until 1894. Taxes were still inconsistent after that and depended mostly on what the government expected to spend in the coming year. The big change in U.S. tax history came in 1913 when 42 of the 48 states ratified the 16th Amendment, which increased the taxing authority of the federal government. In case you're curious, the states that didn't ratify the 16th Amendment were Utah, Virginia, Rhode Island, Florida, Pennsylvania, and Connecticut.

If we look again at the 2013 U.S. marginal tax rates table, we can see that the highest tax bracket is 39.6% for any single-filer income above $400,000. Basically, this means if you're single, once you hit $400,000, your marginal tax rate is 39.6%, meaning the next dollar you make will be taxed at 39.6%.

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