- Remember that under my simple tax system,
if you make $100, you pay $25 of tax.
you pay $25 of tax.
The first $50 is not taxed.
The second $50 is taxed at the rate of 50%,
at the rate of 50%.
so you'll pay a total of $25 tax
if your taxable income is $100.
This allows us to discuss two important concepts,
the average tax rate and the marginal tax rate.
The average tax rate is simply the tax that you owe,
$25 in this case,
divided by how much you made,
$100 in this case.
a hundred dollars in this case.
$25 divided by $100 is 25%.
Twenty-five dollars dividedby a hundred dollars is 25%.
That's the average tax rate.
This is a very simple, intuitive idea.
For example, the average federal tax rate for all taxpayers
in the United States is between 10% and 15%.
Now, note, before you get excited
about this relatively low rate,
remember that this doesn't include state income tax,
sales tax, property tax, social security tax.
Economists say that a more important rate
than the average tax rate is the marginal tax rate.
The marginal tax rate is the rate you'll pay
on the next dollar of income that you make.
The reason that this is an important concept
from an economic standpoint is that this marginal rate
is that this marginal rate isthe rate that I have in mind
is the rate that I have in mind when I'm considering putting
when I'm consideringputting in some extra time
in some extra time and effort and risk to make more money.
and effort and risk to make more money.
I will pay the marginal tax rate on any extra money
from a new business or from working overtime hours.
Let's say that I'm an entrepreneur
with a good business idea.
My current income is $100.
Should I work hard and devote my time and energy
to starting that business and making more money?
Well, in the case of my simple tax system,
if I start that business and make extra money,
I'm going to have to pay the marginal tax rate
of 50% on any new income that I make.
on any new income that I make.
The marginal rate,
that's the number that people have in mind
as they consider whether they should work harder.
Look again at my simple tax system.
You might be asking yourself,
now why exclude some income from taxation?
why exclude some income from taxation?
In this simple system,
why let people make that $50 without paying any tax at all?
Well, the concept here is that
The concept here is that there is a fixed cost to living.
there is a fixed cost to living.
I have to have a certain amount
of money to put a roof over my head,
to put a roof over my headand put food on the table
and put food on the table,
and clothes on my back.
Let's not tax any of that money,
because those are the essentials of life.
Once I've got those things taken care of,
now the government can start to take some tax from me.
This idea of a fixed cost to living is built
into all income tax systems around the world.
Another phrase that you might of heard
is a progressive tax system.
A progressive tax system is one
in which the average tax rate increases
the average tax rate increasesas you make more money.
as you make more money.
My simple system is a progressive tax system.
Let me show you why.
Now, as we saw, if youmake $50, your tax is zero.
As we saw, if you make $50, your tax is zero,
so your average tax rate is 0%.
If you make a hundreddollars, your tax is $25.
If you make $100, your tax is $25,
so your average tax rate is 25%.
If you make a $1000, you pay $475 in tax,
and your average tax rate is 47.5%.
The average tax rate goes up the more money you make.
This is a progressive tax system.
All income tax systems around the world
are designed to be progressive systems.
The average tax rate is the overall rate
of tax you're paying on all of your income.
you are paying on all of your income.
The marginal tax rate is the rate
that you'll pay on the next dollar of income
on the next dollar of income that you make
that you make as your income increases.
as your income increases.