Tax Brackets and Marginal Rates: An Explainer

Photo by Frank Bush on Unsplash
[Photo by Frank Busch on Unsplash]
 
By D.T. Cochrane
13 August 2021
 
 
“I got a raise, but it put me in the next tax bracket, so I’m actually losing money!”
 
Have you ever heard a variation of this claim? It is wrong. Being paid more will not result in lower take-home pay because you move into a higher tax bracket.
 
This notion is based on a misunderstanding of how tax brackets work. 
 
For instance, the federal NDP recently announced that, if elected to government, they would raise the top marginal rate on anyone making over $214,638 from 33% to 35%. That doesn’t mean anyone earning more than $214,638 will pay more on all of their income. It only means they will pay more on the portion of taxable income above $214,368.
 
Tax brackets only apply to segments of income, not segments of the income-earning population.
 
 

HOW TAX BRACKETS ARE APPLIED:

Imagine that you currently have taxable income of $150,000. 
  • A 15% rate will apply to the first $48,535. 
  • Then, a 20.5% rate will apply to the next $48,534. 
  • Finally, a 26% tax rate will apply to your remaining $52,931. 
Your income crosses the two lowest tax brackets, and most of the third.
 
Now imagine that you get a $5,000 raise. 
  • This will push your income through the third bracket and into the fourth, which has a rate of 29%.
  • This rate only applies to $4,527, the amount in the fourth bracket.
  • You will take home at least $3,564 of that $5,000 raise, even though it pushed you into a higher tax bracket.
After relevant tax credits are applied, the take home will almost certainly be even higher. 
 
See below for a visual presentation of the above.
 
 

YOUR MARGINAL TAX RATE

Before the raise, your marginal tax rate was 26%, because it applied to the top margin of your income. But your average tax rate was 20.7%.
 
After the raise, your marginal rate rose to 29%, but your average rate only increased to 20.9%! That's an 0.2% increase on the amount of tax you pay on your entire income.
 
Again, all of this is before the application of credits that will reduce your final tax bill. The basic personal allowance alone will save you more than $1,900 overall.
 
 

PROGRESSIVE MARGINAL TAX RATES

C4TF advocates for more progressive taxation, meaning higher marginal rates for the highest incomes. Not everyone agrees, and some organizations that favour the wealthy deliberately confuse the debate. But to have a proper debate, we need to understand how tax brackets and marginal rates actually work.