How tax brackets actually work

Summary

The script clarifies a common misconception about tax brackets, emphasizing the importance of understanding marginal tax rates. It explains that instead of a flat rate, taxes are paid in 'pockets' with increasing rates as income grows. The 'special pocket' for deductions is highlighted, showing how only the incremental income from a raise is taxed at higher rates, not the entire income. The script aims to demystify tax policy discussions and dispel myths about tax rates affecting the entire income.

Takeaways

• 💡 Tax brackets for 2019 can be misunderstood when calculating federal taxes.
• 📊 A common mistake is thinking that your entire income is taxed at the rate of your highest bracket.
• 💰 Example: An $84,000 income might seem to be taxed entirely at 22%, but this is incorrect.
• 🏦 The government allows a standard deduction ($12,000 for singles), reducing taxable income.
• 📉 After deductions, the remaining income is taxed in portions or 'pockets' at different rates.
• 🔟 The first pocket is taxed at 10% for the first $9,700.
• 📈 The next portion of income is taxed at 12%, and then 22% as income increases.
• 📥 Marginal tax rates mean only the money in the highest bracket gets taxed at that rate.
• 🤑 Raises are taxed at the next available marginal rate pocket, not entirely at the highest rate.
• 🗣️ Politicians' proposals to change tax rates often affect only the highest income brackets, not all income.

Q & A

What is the common mistake people make when looking at tax brackets?

The common mistake is assuming that the entire income is taxed at the rate of the bracket it falls into, rather than understanding that tax rates are applied progressively to different portions of the income.

What is the special pocket mentioned in the script, and how does it work?

The special pocket refers to the standard deduction, which is an amount of income that is not taxed. Single individuals can automatically deduct $12,000, and couples can deduct more, with additional deductions possible for certain expenses like medical expenses or charitable donations.

How does the concept of 'pockets' relate to tax brackets?

The concept of 'pockets' is a metaphor for the progressive nature of tax brackets. Each pocket represents a different portion of income that is taxed at a specific rate, starting from the lowest bracket and moving up as the income increases.

What are marginal tax rates, and how do they apply to an individual's income?

Marginal tax rates are the tax rates applied to each additional dollar of income as it falls into different tax brackets. They apply to the portions of income that have filled up the lower brackets and are then taxed at the next highest rate for the income in the next bracket.

How does a raise affect the taxation of an individual's income?

A raise increases the income in the first available pocket with empty space. Once that pocket is filled, the additional income is taxed at the next higher marginal tax rate, meaning only the raise, and not the entire income, is partially taxed at the new rate.

What does it mean when politicians talk about raising the top tax rate?

When politicians discuss raising the top tax rate, they are referring to increasing the tax rate for the highest income bracket. This does not necessarily affect the tax rates of the lower brackets or the majority of an individual's income.

Why is it important to understand the concept of marginal tax rates?

Understanding marginal tax rates is important because it clarifies how taxation works on different portions of income and helps to dispel misconceptions about how much of one's income the government might 'take away'.

How can deductions affect an individual's taxable income?

Deductions reduce an individual's taxable income by allowing them to subtract certain expenses from their total income before tax rates are applied, potentially lowering the overall tax liability.

What is the purpose of the script in the video?

The purpose of the script is to educate viewers on the correct understanding of tax brackets and marginal tax rates, and to clarify common misconceptions about how taxes are applied to income.

How does the script suggest responding to politicians' claims about tax rates?

The script suggests that viewers should educate themselves on the concept of marginal tax rates and be prepared to challenge politicians' claims by understanding how tax brackets actually work.