April 13, 2023

Four Simple Scenarios Show How Marginal Tax Rates and Breaks Affect What People Actually Pay

All incomes pay taxes, but the rate and types they pay are different. Tax policy is a critical component of our nation’s economic and fiscal landscape, but for individual Americans, the tax system can seem overly complex. Two of the most confusing factors? Marginal tax rates and tax breaks.

This complexity means that the percentage of income that Americans pay in taxes can vary widely and depend on many factors. The United States features a generally progressive income tax structure at the federal level. As income rises, so does an individual’s tax rate. At the same time, high-income Americans benefit disproportionately from tax breaks, otherwise known as tax expenditures. In 2022, such expenditures for individuals and corporations cost $1.7 trillion.

Let’s look at a few examples of how individual Americans would compute their income tax liabilities:

Scenario 1: Single, Part-Time Employee Making $40,000

Olivia is single and earned hourly wages that totaled $40,000 in 2022. She took the $12,950 standard deduction, which made her taxable income $27,050.

Income Tax Rate Total
The first $10,275 10% = $1,028
$10,276 to $27,050 12% = $2,013

Olivia owes a total $3,041 in taxes, which is 7.6% of her total income.

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Scenario 2: Higher earning individual receiving the child tax credit

In the next example, David earns significantly more than Olivia, but he pays a lower percentage of his income, largely because he receives the child tax credit.

David earned a salary of $65,000 in 2022 and is filing taxes as a head of household because he is unmarried and lives with his two young children. During 2022, he paid $800 of student loan interest. After deducting that interest from his income, and taking the standard deduction of $19,400, his taxable income was $44,800.

Income Tax Rate Total
The first $14,650 10% = $1,465
$14,651 to $44,800 12% = $3,618

David would owe a total of $5,083 in taxes, which is 7.8% of his total income. However, because he has two children under the age of 17, he is entitled to a child tax credit of $4,000.

David owes $1,083 in taxes, which is 1.7% of his total income.

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Scenario 3: Leveraging 401(k), IRA, and charitable deduction tax breaks

In the scenario below, Carmen reduced her taxable income in two ways. The first was by making contributions to an employer-sponsored retirement plan, such as a 401(k) or IRA. That is one of the most expensive tax breaks — it cost the government $288 billion in lost revenues in 2022. The second way that she reduced her taxable income was by making a charitable contribution.

Carmen is single and earned a salary of $190,000 in 2022. She contributed $9,500 to an employer-sponsored retirement plan and also donated $15,000 to a local art museum. Together, those two items reduce her taxable income to $165,500.

Income Tax Rate Total
The first $10,275 10% = $1,028
$10,276 to $41,775 12% = $3,780
$41,776 to $89,075 22% = $10,390
$89,076 to $165,500 24% = $18,342

Carmen owes a total of $33,550 in taxes, which is 17.7% of her total income.

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Scenario 4: Leveraging mortgage interest and SALT tax breaks

Noah and Emma are in the top percentile of income earners in the United States, and they are taking advantage of the mortgage interest and state and local tax (SALT) deductions — both of which tend to benefit high-income wage earners more than lower-income groups.

Noah and Emma are married and file their taxes jointly. In 2022, they earned a combined salary of $500,000 and realized $40,000 of short-term capital gains, making their income $540,000. They each contributed $20,000 to their respective employer-sponsored retirement plans, and they also paid $9,500 worth of mortgage interest and $15,000 of property taxes — of which they can deduct $10,000. After deducting those amounts, their taxable income is $480,500.

Income Tax Rate Total
The first $20,550 10% = $2,055
$20,551 to $83,550 12% = $7,560
$83,551 to $178,150 22% = $20,812
$178,151 to $340,100 24% = $38,868
$340,101 to $431,900 32% = $29,376
$431,901 to $480,500 35% = $17,010

Noah and Emma owe a total of $115,681 in taxes, which is 21.4% of their total income.

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The Case for Simplifying the Tax Code

As the scenarios above illustrate, our tax system can be complex and confusing. While the fairness of that system is much debated, many economists agree that simplifying the tax code would promote economic growth and opportunity.

Related: Quiz: How Much Do You Know About the U.S. Tax System?


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