“Hooray, it’s tax season!” said nobody ever, except for the clinically ill and the clinically sarcastic. But I’m here, in this season of paperwork and low spirits, to offer a hymn of praise to the poor, misunderstood public servants that make income taxes work. No, not IRS agents, although goodness knows those sorry devils could use a defender or two.
I’m talking about tax brackets.
Tax brackets enact a simple idea: that not all income should be taxed equally. The first $8000 that I earn is likely to be precious—rent and grocery money.
For me, income above $30,000 is a little less precious—it’s vacation, savings, and new computer money. And if my teaching/blogging career somehow pulled in over $250,000 (I can dream, right?), those last few thousand bucks would be nice, but not terribly precious.
That’s why the tax code grabs a larger share from higher income levels. The more money you have, the less precious an extra dollar becomes. But this is where tax brackets have been maligned and misinterpreted. They don’t apply to people. They apply to money.
To see the difference, consider a simple two-bracket world, where all income below $8000 is taxed at 10% and all income above $8000 is taxed at 20%.
If I earn $1, I pay that low 10% tax rate, which comes out to $0.10.
If I earn $2, I’m still paying just 10%, so my total tax is $0.20.
If I earn $3, I’m still paying 10%, so I pay $0.30 total.
You get the idea. This continues until I earn $8000. All that income is taxed at 10%, so my total income tax bill comes out to $800.
But then my boss comes up and says, “Hey, great work teaching/blogging, Ben! Here’s an extra dollar!” Now I’ve made $8001.
I assume this means I pay 20% tax now… but 20% of $8001 comes out to roughly $1600. That’s double the total tax I was paying before the measly bonus. Did an extra $1 in earnings really just cost me $800 in extra taxes?!
No. That’d be crazy.
The 20% tax applies only to my last dollar earned. That’s $0.20. So my total tax didn’t skyrocket from $800 to $1600. It just nudged upward slightly, from $800 to $800.20.
As I said, brackets don’t make distinctions among people. They only distinguish between different types of money. The first $8000 I earn will always face a 10% tax rate, no matter how much more I go on to earn. Even if I earned a billion dollars, the first $8000 would get taxed at 10%. You, I, and Bill Gates all pay that same 10% on our first $8000.
This system avoids perverse scenarios where earning extra income actually winds up costing me money. In the good ol’ US of A, earning an extra dollar will always increase your taxes, but it’ll always increase your after-tax income, too. When people fret, “Oh no, that’ll bump me up into the next tax bracket!” they’re either joking, crazy, or confused about how taxes work.
When Congress debates, say, a 40% tax rate for people earning more than $250,000, this doesn’t mean a family making $250,001 has to pay 40% of their income in taxes. They’ll only pay 40% on that very last dollar earned.
Does this mean a progressive income tax is better than other systems, like a value-added tax? Not necessarily. But while you’re grumbling about taxes this month, remember to tip your cap to the humble tax bracket, the unsung hero of the IRS.
P.S. Check out HAL 10000’s comment below for a more nuanced take on the rare situations when earning $1 extra really can increase your taxes by more than $1.