Marginal against effective tax rate

A bracket system taxes slices of income, not the whole of it. The first slice pays the first rate, the next slice pays the next rate, and so on up the ladder.

Your marginal tax rate is the rate on the top slice, which is the rate the next dollar you earn would pay. It is the number people mean when they say they are in the 25 percent band.

Your effective tax rate is total tax divided by total income. On the chart it is the average height of the shaded area, which is why the dashed line never rises above the step the marker is standing on. Inside the zero-rate band the two sit level, because nothing has been taxed yet; past it the dashed line drops below the step and stays there. The default income here stands on the 25 percent step and pays 14.44 percent overall, and even at the top of the range the effective rate stays well under 45 percent, because the lower slices keep pulling the average down.

The two numbers answer different questions. Marginal answers what happens to the next dollar. Effective answers what happened to all of them.

Only the income above a threshold pays the higher rate. Cross a threshold by one dollar and exactly one dollar is taxed at the new rate, so take-home still goes up.

The chart shows the size of it. The darker slice of the shaded area is the part of income paying the top rate reached. Set the marker just past a threshold and that slice is almost nothing. Drag further and it grows, which is why the effective rate creeps up gradually instead of jumping when the step does.

What you keep from extra income is one minus the marginal rate. In the 25 percent band you keep three quarters of a raise. In the 45 percent band you keep a little over half. Smaller, never negative.

There is a real version of the fear, and it is not the brackets. Means-tested benefits, tapered allowances and eligibility cut-offs can withdraw money at a set income, and a few of those are cliff edges rather than tapers, so a small raise can leave someone worse off. That is the benefit rule doing it, not the tax band, and the fix is to read the rules for that specific payment.

The bands in this tool are illustrative round numbers picked so the staircase reads clearly at phone width. They are not any published schedule. Real systems differ on every axis:

• Thresholds and rates differ by country, and often by state, province or region stacked on top of the national schedule.
• Thresholds move. Many are indexed to inflation each year and some are frozen for long stretches, and freezing a threshold raises effective rates without changing a single published rate.
• Filing status changes the table. Single, joint and head-of-household schedules can put different thresholds under the same rate.
• Not all income climbs the same ladder. Long-term capital gains, dividends and some savings income often carry their own rates.
• Other taxes stack. Payroll or social insurance contributions and local income taxes each bring their own thresholds.
• Allowances and credits move the answer. A deduction cuts taxable income and is worth your marginal rate. A credit cuts the tax bill directly and is worth its face value.

The input this tool asks for is taxable income, meaning what is left after allowances and deductions rather than gross pay. This is educational material rather than tax or financial advice, and the rates for your own situation come from your tax authority or a qualified adviser.