What does marginal tax rate refer to?

The marginal tax rate refers specifically to the rate of tax that applies to the last dollar of income earned. This concept is crucial in understanding how income tax systems operate, particularly progressive tax systems where rates increase with income levels.

When individuals earn additional income, the marginal tax rate determines how much of that extra income will be taxed at a higher rate. This means that each additional dollar earned does not necessarily mean that one’s overall income will be taxed at that same rate. Instead, it focuses on the tax rate applicable to the portion of income that falls into the highest bracket of income the taxpayer is in.

This concept is particularly useful for individuals when making decisions about working additional hours or when considering raises or investment income, as it directly impacts how much extra income they can keep after taxes. Understanding the marginal tax rate can help taxpayers make informed financial decisions regarding income and tax liability.