 # What You Need to Know About Tax Brackets

## How do taxes work?

If you watch the news, you’ve heard politicians argue about tax rates. Republicans argue that tax rates are too high, Democrats want them to be higher. They throw around high tax rates as if everyone’s going to be subject to them, which is definitely not true. In fact, most of the time when you hear a tax rate discussed, it applies only to a very small percentage of top income earners, while the rest of us pay a much lower rate.

The most important thing to understand when it comes to tax rates is that your taxes are calculated using a series of income “brackets”, each of which is taxed at a different rate. The lowest part of your income is taxed at a low rate, and as you earn more and more, the next “chunks” of your income are taxed at progressively higher rates. Sound complicated? It’s easy to understand once you learn the basics. The easiest way to explain it is through some examples.

Let’s go through some sample income calculations to illustrate the difference between a simple, flat tax and the more complicated bracketed system we use in the US. In these examples, we’re using only three brackets to make it easier to understand (in reality there are seven in 2018), and showing examples for three different income earners.

### Flat Tax

Flat tax is the simplest way to assess taxes, and it’s the method many Americans mistakenly believe we use. In a flat tax system, your taxable income is multiplied by a tax rate to calculate the amount of tax owed. Flat tax results in everyone paying the same tax rate; switching from our current bracketed system to a flat tax system would lower overall taxes for higher earners, and increase taxes for lower earners.

Example of tax calculation using a flat tax rate system (tax rate of 30% for all income)

• For income of \$25,000: \$25,000 x 0.30 = \$7,500 tax owed
• For income of \$100,000: \$100,000 x 0.30 = \$30,000 tax owed
• For income of \$1,000,000: \$1,000,000 x 0.30 = \$300,000 tax owed

In this system, everyone is subject to the same tax rate, 30%.

### Bracketed Tax Rates

Tax “brackets” refer to income ranges. For each range, a different tax rate applies, starting with low tax rates that increase as income increases. Bracketed tax systems like ours result in everyone paying a different overall tax rate, with lower income earners paying a lower rate, and higher earners paying a higher rate.

Example of tax calculation using a bracketed tax rate system (tax rate for first \$30,000 of income: 10%; tax rate for \$30,000 to \$80,000 of income: 30%; tax rate for income over \$80,000: 40%)

• For income of \$25,000: \$25,000 x 0.10 = \$2,500
• For income of \$100,000: \$30,000 x 0.10 = \$3,000; \$50,000 x 0.30 = \$15,000; \$20,000 x 0.40 = \$8,000; total taxes owed: \$31,000
• For income of \$1,000,000: \$30,000 x 0.10 = \$3,000; \$50,000 x 0.30 = \$15,000; \$920,000 x 0.40 = \$368,000; total taxes owed: \$386,000

Note that in a bracketed tax system, each of these example taxpayers is paying a different overall tax rate: for \$25,000 in income, the tax rate is 10% (2,500 ÷ 25,000). For \$100,000 in income, the tax rate is 31% (31,000 ÷ 100,000). And for \$1,000,000 in income, the tax rate is 38.6% (386,000 ÷ 1,000,000).

### Understanding US Tax Brackets 