Tax Structure: Tax Base, Tax Rate, Proportional, Regressive, and Progressive Taxation
The tax structure of an economy depends on its tax base, tax rate, and how the tax rate varies. The tax base is the amount to which a tax rate is applied. The tax rate is the percentage of the tax base that must be paid in taxes. To calculate most taxes, it is necessary to know the tax base and the tax rate. So if the tax base equals $100 and the tax rate is 9%, then the tax will be $9 (=100 × 0.09). Proportional taxes (aka flat-rate taxes) apply the same tax rate to any income level, or for any size tax base. So if Bill earns $50,000 and Jane earns $100,000, and the tax rate is 10%, then Bill will owe $5,000 in taxes while Jane will owe $10,000. Many state income taxes and most sales taxes are proportional taxes. Social Security and Medicare taxes are also proportional since the same tax rate is applied to any earned income up to the Social Security wage base limit, which, for 2021, is $142,800. The Medicare tax is a proportional tax that applies to all earned income, = 2.9%. Flat taxes are a fixed amount and do not depend on income or transaction values, such as a $10 per capita tax.
A regressive tax is higher at lower incomes. The most prominent regressive tax is the Social Security tax, because the tax drops to 0, when earned income exceeds the Social Security wage base limit. Regressive taxes especially hurt the poor. The inequitable effects of regressive or proportional taxes are often mitigated by payments to the poor and by exempting essential products and services, such as food, from regressive and proportional taxes.
A tax can also be regressive if it places a greater burden on poorer people. Flat taxes, for instance, place a greater burden on poor people because, even though the tax is the same for everyone, the tax is a greater proportion of income for a poor person than for a rich person. Even proportional taxes can be regressive. For instance, if the tax rate was 10% for everyone, that 10% of income represents a greater burden for poor people because they need all their money to live. Taking 10% from a rich person would not lower their standard living at all because they have so much more than what they need to live well. The marginal utility of money declines with increasing wealth, so much so that taking 10% from someone who makes $10,000 annually is much more burdensome than taking 10% from someone who earns $1 million annually, even though the tax revenue from the wealthy person is $100,000 while the tax revenue from the poor person is only $1000. This is why some rich people pay many millions of dollars for a painting or other collectible: they do not use it to improve their quality of life, they invest it or they buy it to flaunt their wealth.
A progressive tax applies a higher tax rate to higher incomes. So if the tax rate on $50,000 is 10% and 20% for $100,000, then, continuing the above example, Bill still owes $5,000 in taxes while Jane must pay $20,000 in taxes. However, most progressive taxes are structured as a marginal tax, meaning that the progressive tax rate only applies to that part of the income exceeding a certain amount. The portion of the tax base subject to a particular tax rate, called a tax bracket, always has lower and upper limits, except for the top tax bracket, which has no upper limit. To see the current rates published by the IRS, scroll down to the bottom of the current tax table from the instructions for Form 1040.
Continuing the above example, if the 20% tax rate is only applied to that portion of the income between $50,000 and $100,000, then Jane would owe $5000 on the first $50,000 of income and $10,000 on the 2nd $50,000 of income, a total tax liability of $15,000.
Without marginal tax rates, a progressive tax would skew economic decisions and would be viewed as unfair. For instance, if the 20% tax rate was applied to all earned income and Jane only earned $60,000, then she must pay $12,000 in taxes, 2.4 times more than Bill's taxes, even though she only made 1.2 times more than Bill. A more extreme example, consider what happens if Jane makes $50,001. Then she must pay $10,000, $5000 more than what Bill must pay, even though he earned only $1 less. Hence, without marginal tax rates, a pay increase could decrease disposable income.
A progressive, marginal tax rate also makes economic sense, since money, like everything else, has a declining marginal utility. In other words, $1 is worth a lot more to someone who earns $10,000 annually than to someone who makes $10 million annually. Poor people need the money to buy essentials, whereas rich people spend their money for luxuries, so the wealthy can pay higher taxes without seriously lowering their standard of living.
The new Republican tax policy, passed at the end of 2017, the Tax Cuts and Jobs Act, has changed the tax brackets for 2018 and afterwards. Congruent to the Republicans' tax objective to benefit the wealthy, most of the benefits in the change to tax brackets go to those earning more than $200,000. The marriage penalty has also been eliminated for all tax brackets, except the top 2.
Tax Brackets | 10% | 12% | 22% | 24% | 32% | 35% | 37% |
---|---|---|---|---|---|---|---|
2024 | |||||||
Single | $11,600 | $47,150 | $100,525 | $191,950 | $243,725 | $609,350 | Excess Amount over 35% Bracket |
HOH | $16,550 | $63,100 | $100,500 | $191,950 | $243,700 | $609,350 | |
MFJ, QSS | $23,200 | $94,300 | $201,050 | $383,900 | $487,450 | $731,200 | |
MP | 2 | 2 | 2 | 2 | 2 | 1.2 | 1 |
2023 | |||||||
Single | $11,000 | $44,725 | $95,375 | $182,100 | $231,250 | $578,125 | Excess Amount over 35% Bracket |
HOH | $15,700 | $59,850 | $95,350 | $182,100 | $231,250 | $578,100 | |
MFJ, QSS | $22,000 | $89,450 | $190,750 | $364,200 | $462,500 | $693,750 | |
MP | 2 | 2 | 2 | 2 | 2 | 1.2 | 1 |
|
Note that tax rates and tax brackets apply only to taxable income. In the United States, people can claim the standard deduction or itemized deductions and other deductions, which lowers taxable income. Therefore, marginal tax rates apply only to income exceeding that amount. Tax bracket limits also only apply to taxable income, not gross income. For instance, if a single taxpayer had $20,000 of deductions, then that $20,000 is not taxed at all. If this taxpayer earned a total $30,000 in 2022, then only $10,000 of that income is subject to the 10% bracket. Without the deductions, the 1st $10,275 would be in the 10% bracket and the remaining income would in the 12% bracket, resulting in a much higher tax.
Some nontaxable income, such as the home sale exclusion and inheritances, are excluded from income, so not only do tax rates not apply to that income, but their exclusion could allow taxpayers to claim tax credits designed for low-income people, such as the earned income credit, that cannot be achieved with deductions, since many tax credits depend on modified adjusted gross income, which adds back some deductible items.
Because of marginal tax rates and nontaxable income, the tax rate that one actually pays is not knowable just from their tax bracket, so another rate, called the effective tax rate (aka average tax rate), is calculated by dividing the actual taxes paid by the gross income of the taxpayer. If all income is taxable, then the total tax calculated by multiplying earned income times the effective tax rate will equal the same tax calculated by multiplying the income amount in each tax bracket by the respective marginal tax rate and summing them all up. So in example 2, since Jane earned $100,000 and paid $15,000 in taxes, her effective tax rate is 15% (= $15,000 ÷ $100,000).
The federal income tax and many state taxes are progressive. Although the federal income tax itself is progressive, the effective tax rate based on all taxes collected by the federal government is progressive only until the Social Security limit is reached. Thereafter, the effective tax rate either declines or levels off with increasing income, since people who make more than the Social Security limit do not have to pay the 12.4% tax on any income exceeding the limit, as can be seen from the next table for a single person who is not a head of the household (Note: For a self-employed person, the tax code allows the deduction of the employer's half of the payroll tax, which results in a net self-employment tax of 14.13%. The tax code also allows the deduction of the employer's portion of the tax, whose value depends on the taxpayer's marginal tax bracket, but since this does not change the effective tax rate very much, it is ignored in the table below. This table assumes that a single person with no dependents pays the entire payroll tax, which is true for the self-employed, but also applies to employees. Even though employees technically only pay 1/2 of the payroll tax, most economists agree that most employees pay the other half through lower wages or through higher unemployment. For more info, see Tax Incidence: How The Tax Burden Is Shared Between Buyers And Sellers):
Earned Income | Income Tax | Payroll Tax | Total Tax | Effective Tax Rate | SE Tax | SE Effective Tax Rate | Effective Marginal Rate | Capital Gains Tax | Effective Capital Gains Rate | Inheritance |
$20,000 | $745 | $2,913 | $3,658 | 18.29% | $4,599 | 26.72% | 3.73% | $0 | 0.00% | 0.00% |
$40,000 | $3,095 | $4,703 | $7,798 | 19.50% | $7,425 | 26.30% | 7.74% | $0 | 0.00% | 0.00% |
$60,000 | $6,188 | $6,493 | $12,681 | 21.13% | $10,251 | 27.40% | 10.31% | $1,058 | 1.76% | 0.00% |
$80,000 | $10,588 | $8,283 | $18,871 | 23.59% | $13,077 | 29.58% | 13.23% | $4,058 | 5.07% | 0.00% |
$100,000 | $15,009 | $10,073 | $25,082 | 25.08% | $15,903 | 30.91% | 15.01% | $7,058 | 7.06% | 0.00% |
$120,000 | $19,809 | $11,863 | $31,672 | 26.39% | $18,729 | 32.12% | 16.51% | $10,058 | 8.38% | 0.00% |
$140,000 | $24,609 | $13,653 | $38,262 | 27.33% | $21,555 | 32.97% | 17.58% | $13,058 | 9.33% | 0.00% |
$160,000 | $29,409 | $13,212 | $42,621 | 26.64% | $22,329 | 32.34% | 18.38% | $16,058 | 10.04% | 0.00% |
$180,000 | $34,411 | $13,502 | $47,913 | 26.62% | $22,865 | 31.82% | 19.12% | $19,058 | 10.59% | 0.00% |
$200,000 | $40,811 | $13,792 | $54,603 | 27.30% | $23,514 | 32.16% | 20.41% | $22,058 | 11.03% | 0.00% |
$220,000 | $47,211 | $14,082 | $61,473 | 27.94% | $24,230 | 32.47% | 21.46% | $25,341 | 11.52% | 0.00% |
$240,000 | $54,152 | $14,372 | $68,884 | 28.70% | $24,946 | 32.96% | 22.56% | $29,101 | 12.13% | 0.00% |
$260,000 | $61,152 | $14,662 | $76,354 | 29.37% | $25,662 | 33.39% | 23.52% | $32,861 | 12.64% | 0.00% |
$280,000 | $68,152 | $14,952 | $83,824 | 29.94% | $26,378 | 33.76% | 24.34% | $36,621 | 13.08% | 0.00% |
$300,000 | $75,152 | $15,242 | $91,294 | 30.43% | $27,094 | 34.08% | 25.05% | $40,381 | 13.46% | 0.00% |
$320,000 | $82,152 | $15,532 | $98,764 | 30.86% | $27,810 | 34.36% | 25.67% | $44,141 | 13.79% | 0.00% |
$340,000 | $89,152 | $15,822 | $106,234 | 31.25% | $28,526 | 34.61% | 26.22% | $47,901 | 14.09% | 0.00% |
$360,000 | $96,152 | $16,112 | $113,704 | 31.58% | $29,242 | 34.83% | 26.71% | $51,661 | 14.35% | 0.00% |
$380,000 | $103,152 | $16,402 | $121,174 | 31.89% | $29,958 | 35.03% | 27.15% | $55,421 | 14.58% | 0.00% |
$400,000 | $110,152 | $16,692 | $128,644 | 32.16% | $30,674 | 35.21% | 27.54% | $59,181 | 14.80% | 0.00% |
$420,000 | $117,152 | $16,982 | $136,114 | 32.41% | $31,390 | 35.37% | 27.89% | $62,941 | 14.99% | 0.00% |
$440,000 | $124,152 | $17,272 | $143,584 | 32.63% | $32,106 | 35.51% | 28.22% | $66,701 | 15.16% | 0.00% |
$460,000 | $131,152 | $17,562 | $151,054 | 32.84% | $32,822 | 35.65% | 28.51% | $70,541 | 15.33% | 0.00% |
$480,000 | $138,152 | $17,852 | $158,524 | 33.03% | $33,538 | 35.77% | 28.78% | $75,301 | 15.69% | 0.00% |
$500,000 | $145,152 | $18,142 | $165,994 | 33.20% | $34,254 | 35.88% | 29.03% | $80,061 | 16.01% | 0.00% |
$520,000 | $152,152 | $18,432 | $173,464 | 33.36% | $34,970 | 35.99% | 29.26% | $84,821 | 16.31% | 0.00% |
$540,000 | $159,229 | $18,722 | $181,011 | 33.52% | $35,686 | 36.10% | 29.49% | $89,581 | 16.59% | 0.00% |
$560,000 | $166,629 | $19,012 | $188,881 | 33.73% | $36,402 | 36.26% | 29.76% | $94,341 | 16.85% | 0.00% |
$580,000 | $174,029 | $19,302 | $196,751 | 33.92% | $37,118 | 36.40% | 30.00% | $99,101 | 17.09% | 0.00% |
$600,000 | $181,429 | $19,592 | $204,621 | 34.10% | $37,834 | 36.54% | 30.24% | $103,861 | 17.31% | 0.00% |
$620,000 | $188,829 | $19,882 | $212,491 | 34.27% | $38,550 | 36.67% | 30.46% | $108,621 | 17.52% | 0.00% |
$640,000 | $196,229 | $20,172 | $220,361 | 34.43% | $39,266 | 36.80% | 30.66% | $113,381 | 17.72% | 0.00% |
$660,000 | $203,629 | $20,462 | $228,231 | 34.58% | $39,982 | 36.91% | 30.85% | $118,141 | 17.90% | 0.00% |
$680,000 | $211,029 | $20,752 | $236,101 | 34.72% | $40,698 | 37.02% | 31.03% | $122,901 | 18.07% | 0.00% |
$700,000 | $218,429 | $21,042 | $243,971 | 34.85% | $41,414 | 37.12% | 31.20% | $127,661 | 18.24% | 0.00% |
$720,000 | $225,829 | $21,332 | $251,841 | 34.98% | $42,130 | 37.22% | 31.37% | $132,421 | 18.39% | 0.00% |
$740,000 | $233,229 | $21,622 | $259,711 | 35.10% | $42,846 | 37.31% | 31.52% | $137,181 | 18.54% | 0.00% |
$760,000 | $240,629 | $21,912 | $267,581 | 35.21% | $43,562 | 37.39% | 31.66% | $141,941 | 18.68% | 0.00% |
$780,000 | $248,029 | $22,202 | $275,451 | 35.31% | $44,278 | 37.48% | 31.80% | $146,701 | 18.81% | 0.00% |
$800,000 | $255,429 | $22,492 | $283,321 | 35.42% | $44,994 | 37.55% | 31.93% | $151,461 | 18.93% | 0.00% |
$820,000 | $262,829 | $22,782 | $291,191 | 35.51% | $45,710 | 37.63% | 32.05% | $156,221 | 19.05% | 0.00% |
$840,000 | $270,229 | $23,072 | $299,061 | 35.60% | $46,426 | 37.70% | 32.17% | $160,981 | 19.16% | 0.00% |
$860,000 | $277,629 | $23,362 | $306,931 | 35.69% | $47,142 | 37.76% | 32.28% | $165,741 | 19.27% | 0.00% |
$880,000 | $285,029 | $23,652 | $314,801 | 35.77% | $47,858 | 37.83% | 32.39% | $170,501 | 19.38% | 0.00% |
$900,000 | $292,429 | $23,942 | $322,671 | 35.85% | $48,574 | 37.89% | 32.49% | $175,261 | 19.47% | 0.00% |
$920,000 | $299,829 | $24,232 | $330,541 | 35.93% | $49,290 | 37.95% | 32.59% | $180,021 | 19.57% | 0.00% |
$940,000 | $307,229 | $24,522 | $338,411 | 36.00% | $50,006 | 38.00% | 32.68% | $184,781 | 19.66% | 0.00% |
$960,000 | $314,629 | $24,812 | $346,281 | 36.07% | $50,722 | 38.06% | 32.77% | $189,541 | 19.74% | 0.00% |
$980,000 | $322,029 | $25,102 | $354,151 | 36.14% | $51,438 | 38.11% | 32.86% | $194,301 | 19.83% | 0.00% |
$1,000,000 | $329,429 | $25,392 | $362,021 | 36.20% | $52,154 | 38.16% | 32.94% | $199,061 | 19.91% | 0.00% |
$1,020,000 | $336,829 | $25,682 | $369,891 | 36.26% | $52,870 | 38.21% | 33.02% | $203,821 | 19.98% | 0.00% |
$1,040,000 | $344,229 | $25,972 | $377,761 | 36.32% | $53,586 | 38.25% | 33.10% | $208,581 | 20.06% | 0.00% |
$1,060,000 | $351,629 | $26,262 | $385,631 | 36.38% | $54,302 | 38.30% | 33.17% | $213,341 | 20.13% | 0.00% |
$1,080,000 | $359,029 | $26,552 | $393,501 | 36.44% | $55,018 | 38.34% | 33.24% | $218,101 | 20.19% | 0.00% |
$1,100,000 | $366,429 | $26,842 | $401,371 | 36.49% | $55,734 | 38.38% | 33.31% | $222,861 | 20.26% | 0.00% |
$1,120,000 | $373,829 | $27,132 | $409,241 | 36.54% | $56,450 | 38.42% | 33.38% | $227,621 | 20.32% | 0.00% |
$1,140,000 | $381,229 | $27,422 | $417,111 | 36.59% | $57,166 | 38.46% | 33.44% | $232,381 | 20.38% | 0.00% |
$1,160,000 | $388,629 | $27,712 | $424,981 | 36.64% | $57,882 | 38.49% | 33.50% | $237,141 | 20.44% | 0.00% |
$1,180,000 | $396,029 | $28,002 | $432,851 | 36.68% | $58,598 | 38.53% | 33.56% | $241,901 | 20.50% | 0.00% |
$1,200,000 | $403,429 | $28,292 | $440,721 | 36.73% | $59,314 | 38.56% | 33.62% | $246,661 | 20.56% | 0.00% |
The 2021 standard deduction of $12,550 for a single taxpayer was deducted from the earned income to calculate the income tax in the above table. However, payroll taxes applies to all earned income. As you can see from the chart below, the federal tax on earned income is not nearly as progressive as it might seem by just looking at marginal tax rates. It is also obvious that work is the most highly taxed form of income. Investment income subject only to the short-term capital gains rate is subject only to the marginal tax rate, which is also listed in 1 of the columns above; employment taxes do not apply. Investors receiving all their income as long-term capital gains or from qualified dividends pay a much lower tax rate. These rates also do not include the many deductions that higher income taxpayers can take advantage of, so these are the maximum rates that would apply, based on income.
The Wealthy Really Have It Better
The above table suggests that the wealthy pay a higher effective tax rate on their income than poorer people. However, because of favorable tax treatment for investment income and, especially for capital gains, and because large amounts of wealth can be transferred through gifts and inheritance (collectively, gratuitous transfers) tax-free, the wealthy actually pay a far lower effective tax rate if the taxes that they paid is divided by all their income, including investment income and inherited wealth.
For instance, IRS statistics frequently show that the top 400 taxpayers of the United States pay about 18% of their income in taxes, including payroll taxes that they may have paid. If you look at the above table again, you will note that a self-employed person who makes a mere $20,000 annually pays an effective tax rate of almost 18% — even after subtracting the standard deduction! Furthermore, hedge fund managers, some who make more than $1 billion annually, are exempted from paying any payroll taxes on their performance fee, which is most of their compensation if they are profitable, thanks to their Republican friends in Congress.
The largest single factor creating this inequity in taxation is the fact that earned income is the most highly taxed income, even though, for maximum economic growth, earned income should be the least taxed, because the higher price of wages due to these income taxes decreases the demand for labor while the lower amount received by the suppliers of this labor reduces supply — reducing economic growth through the deadweight loss of taxation. Indeed, only work increases the economic wealth of any society. Even investments cannot create true economic wealth unless it is used to put people to work, and transferred wealth actually reduces economic wealth because the recipients have a reduced incentive to work. Hence, the prudent economic policy of any government should be to tax work the least and gratuitous transfers the most.