Understanding Tax Tables/Tax Brackets and a Progressive Tax System
Tax tables are derived from tax brackets which are one of the hallmarks of a progressive tax system (also sometimes called a “graduated” tax system). Most progressive tax systems are in place so that taxpayers pay a larger percentage of their income as their incomes increase. The United States’ federal income tax system is progressive as are most states (more here).
This system differs from proportional taxation. The tax rate in a proportional system is fixed or flat: it does not change if the base on which the tax is calculated increases or decreases. The tax rate in a progressive tax system, on the other hand, increases as the base amount increases. For instance, assume that individual X earns $20,000 in one tax year and individual Y earns $40,000 in the same tax year. If X and Y are subject to a proportional income tax imposed at the rate of 20%, then X pays $4,000 in income tax and Y pays $8,000. In a progressive system, Y would pay at a higher rate than X because Y earned more. Assume that the rate for someone earning $20,000 is 15%, while the rate for someone earning $40,000 is 25%. In this, example, X would pay $3,000 and Y would pay $10,000. The difference in the amounts paid by taxpayers with different income levels is usually greater in a progressive system than in a proportional system.
Several Western European countries initiated progressive income tax systems in the 1890s. The permanent income tax enacted by the United States in 1913 began as a progressive system. The tax was imposed at that time was the rate of 1% on amounts of income over $3,000 and not more than $50,000, and increased to a rate of 6% on amounts over $500,000. By that time, progressive taxation had generally come to be thought of as fairer than proportional taxation. Various arguments since have been advanced in favor of progressivity.
- According to the theory of “benefit taxation,” people who earn more are likely to receive greater benefits from public expenditure and, thus, should pay more.
- The “ability-to-pay” principle assumes that people who earn more are able to pay more.
- Under the “equal marginal sacrifice” concept (a specific version of ability-to-pay theory), the rates should impose an equal burden on everyone; Y’s payment of $10,000 in the example above should impose the same sacrifice on Y as X’s payment of $3,000 imposes on X.
- The doctrine of “declining marginal utility” assumes that the next dollar earned is worth less to a person with more money than to a person with less money.
Tax Tables & Brackets
Section 3 of the Internal Revenue Code directs the IRS to publish tax tables annually for individuals. The tables include rates, a range of personal income under each rate as well as an estimated taxable income.
The tables allow taxpayers to estimate their liability without making computations. The tax tables for each year’s 1040 are published in a booklet (2016 tax tables can be found here). The tables contain very narrow ranges of taxable income so that you can arrive at an amount that is as precise as possible.
The tax tables provide estimates for income under $100,000 and a worksheet for incomes above that. Of course, our software will always automatically calculate a users exact liability so estimating is not required.
The federal tax system is progressive through various brackets. A bracket is a range of incomes separated from other ranges and given a certain percentage tax rate. For ordinary income, there are seven brackets, each tied to a rate (percentage): 10%, 15%, 25%, 28%, 33%, 35%, and 39.6%. Tax rates increase as income increases. A range of income, from a base amount to a ceiling amount, falls within each bracket. The range varies, depending on filing status (single, married filing jointly, married filing separately, or head of household).
For example, a single taxpayer’s rates for tax year 2016 (for tax returns that were due, without extension, on April 17, 2017) are as follows:
- Income up to $9,275 is in the 10% bracket
- $9,276 to $37,650 is 15%
- $37,651 to $91,150 is 25%
- $91,151 to $190,150 is 28%
- $190,151 to $413,350 is 33%
- $413,351 to $415,050 is 35%
- Income of $415,051 or more is 39.6%
The tax rates for each bracket are derived from section 1 of the Internal Revenue Code, but are adjusted for inflation each year. The inflation adjustment is designed to prevent “bracket creep,” in which taxpayers would be pushed into higher brackets because of inflation rather than increases in their income levels.
Marginal and Effective Rates
Not all taxpayer income is subject to the rate in which their bracket falls. For example, if a single filer's income falls between $37,651 and $91,150 (25% bracket), only the amount over $37,650 is taxed at the 25% rate. The first $9,275 this individual earns is taxed at 10%, the next $28,375 is taxed at 15%. Just the income over $37,650 is taxed at 25%.
A more precise way of presenting the 2016 rates for single filers would be as follows:
- On income between $0 to $9,275 you pay 10%.
- Between $9,276 to $37,650 you pay 15% plus $927.50 (because $927.50 is 10% of $9,275).
- $37,651 to $91,150 you pay 25% plus $5,183.75 (because $5,183.75 is $927.50 plus 15% of $28,375, which is the difference between $37,650 and $9,275). $91,151 to $190,150 you pay 28% plus $18,558.75.
- $190,151 to $413,350 you pay 33% plus $46,278.75.
- $413,351 to $413,050 you pay 35% plus $119,934.75.
- Income over $415,050 you pay 39.6% plus $120,529.75.
Only the last dollar of income determines the bracket into which a taxpayer falls. Someone making $40,000 annually pays roughly $5,771 or 14.4% of their income. This is their effective tax rate, where the last rate which they are taxed (25%) is their marginal rate.
Confusion about marginal and effective rates is the reason people are sometimes reluctant to move into a higher tax bracket. The reluctance is largely misplaced. Suppose a taxpayer is given a raise from $35,000 annually to $40,000. If all of this income were taxed at the marginal rate, then this taxpayers after-tax situation would barely change since they are moving from the 15% bracket into the 25% bracket. Fortunately, for all taxpayers only the income within the new bracket is taxed at the 25% rate.
Capital Gains Rates
The federal taxation of "capital gains" (see more here) is also progressive.
The tax rates on short-term capital gains (gains from the sale of investments or assets held for one year or less) are the same as the rates for ordinary income. Short-term capital gains run through the brackets in the same way that ordinary income does in the examples above.
Generally, long-term capital gains (gains from the sale of investments held for more than one year) fall into three brackets, but these three brackets are tied to the seven brackets for ordinary income (and short-term capital gain).
- A taxpayer in either the 10% or 15% ordinary-income brackets pays 0% long-term capital-gains.
- In the 25%, 28%, 33%, or 35% brackets pays 15% long-term capital-gains.
- In the 39.6% bracket pays 20% long-term capital gains.
States may also impose their own capital gains rates.