These are tax brackets for 2019. Simple, right? But many of us make a common mistake when looking at this. Let’s say my income is $84,000. You might think that puts me in the third bracket.
So I would owe the federal government 22% of my income. This is wrong. And it’s causing us to have uninformed debates about tax policy. Here’s how it actually works. Let’s go back to my $84,000 income.
Now, instead of thinking of tax rates as brackets, we should think of them as pockets. But first there’s one special pocket we need to talk about. The money we put in this pocket is not taxed. The government automatically lets single people put $12,000 in this special pocket — and more for couples. But if you spend a lot of money on things like medical expenses or charitable donations, you can sometimes put in more.
These are called “deductions.” With the $70,000 that’s left over we can start filling up the pockets.
This first pocket has room for $9,700, so I only pay 10% on this money. Then I pay 12% on the money in the next pocket. And then 22% on the money in this pocket.
These are called marginal tax rates. And that’s how these brackets actually work. So if I get a raise, that new money goes into the first pocket with empty space. When space runs out, we put it in the next pocket. So the raise, and only the raise, would be partially taxed at 22%.
And partially at 24%. So, when politicians say they want to raise the top tax rate, it doesn’t necessarily mean these pockets — and your money — are affected. They’re talking about the tax rates on the pockets way over there, which are only used once people have filled in these smaller one. Marginal tax rates are a pretty simple concept, once you get the hang of it. So the next time a politician says the government wants to “take away 70% of your income” just send them this video.