Thaddeus.net Blog
Understanding tax brackets: What few know and many exploit
I was talking to a friend recently about tax philosophy and was reminded of the fact that most people don't understand how tax brackets work. Many people know what tax bracket they're in (e.g. 28%), but they don't realize that doesn't mean that they pay a flat 28% before deductions. Taxes in the US are bracketed, so millionaires pay the same amount as the minimum wage earner at the burger joint down the street on the first few thousand dollars they earn.
The tax rates in the US are bracketed as according to this table (for 2010):
| Income | Tax rate |
|---|---|
| $0 - $8,375 | 10% |
| $8,375 - $34,000 | 15% |
| $34,000 - $82,400 | 25% |
| $82,400 - $171,850 | 28% |
| $171,850 - $373,650 | 33% |
| $373,650 and up | 35% |
A lot of people find this confusing and incorrectly assume that if you make $82,000 one year and get a meager raise to $83,000 the next year then your tax rate will go up dramatically. This is entirely incorrect.
With a bracketed tax system, you get taxed the same rate as everyone else on the first $8,375, the next $25,625 and so on. So you're really only paying the rate for your top bracket on the amount you made over the previous bracket. Here's a graphical example:
This confusion is often exploited to make people think that they're getting a raw deal. If the tax rate is reduced for the lowest tax bracket then everyone, including millionaires is getting a tax cut. Bear this fact in mind next time someone crows about the tax burden on the ultra-wealthy.