The Tax Rate, or How Much Is Taxed?
Taxes are charged as a percentage of the thing being taxed (which is known as the Tax Base, discussed next); this percentage is known as the Tax Rate. The tax base multiplied by the tax rate determines how much is ultimately owed in taxes. That is,
(Tax base) x (Tax rate) = tax owed
These two things are separate from each other and key to understanding how people owe different taxes even if they have the same total income. Tax rates vary between different types of taxable bases, so focusing wealth in low-rate (or exempt) bases allows people to minimize what they owe in taxes.
There are three different types of taxes; a flat rate, a progressive marginal rate, and a regressive marginal rate.
The Flat Rate
The flat rate is straightforward; everybody pays the same percentage in tax no matter how much of the tax base they are paying on. The most common example of this is a sales tax. For a flat rate tax, the rate is the same no matter how much of something is being purchased, even if the tax may be a different rate depending on what is being purchased (or, as mentioned in the previous section, some types of purchases may be exempt from the tax entirely). This makes it flat.
If the sales tax rate on T-shirts (which is the tax base) is 7%, then I can buy $10 T-shirts and pay $0.70 in taxes ($10 x 0.07 = $0.70) or I can buy $10,000 of T-shirts and pay $700 in taxes ($10,000 x 0.07 = $700). I am paying 7% of the price of the T-shirts in taxes, no matter how much I buy.
Progressive and Regressive Marginal Tax Rates
Marginal tax rates require only slightly more math because they change rate depending on how much of the base is being taxed.
Progressive Marginal Tax Rate
A progressive rate increases the proportion a person owes as the tax bracket increases.
Regressive Marginal Tax Rate
A regressive rate decreases the proportion a person owes as the tax bracket increases.
In order to understand tax brackets, imagine that the base being taxed at marginal rates falls into several buckets, each of which is a bracket. The first bucket can hold a certain amount - say, $10,000 - and once that bucket has been filled, but only once the bucket is full, the wealth goes into the next bucket. The second bucket, in turn, can hold a certain amount - say, $30,000 - and once it is filled, the wealth goes into the third bucket. This continues until Congress doesn’t want any more buckets, and then they make an infinitely large bucket that holds anything above a certain amount. This means that someone making $55,000 with the buckets above would have $10,000 in their first bucket, $30,000 in their second bucket, and then $15,000 in their third bucket. ($10,000 + $30,000 + $15,000 = $55,000, so this accounts for their full income)
Each bucket, then, is taxed at a different rate. The first bucket might be taxed at 10%, the second bucket might be taxed at 12%, and the third bucket might be taxed at 22%. This means that the money in the first bucket is taxed at 10%. The money in the second bucket - and only the money in the second bucket - is taxed at 12%. The money in the third bucket - and only the money in the third bucket - is taxed at 22%.
In the example above, the person making $55,000 has filled their first two buckets and has $15,000 in their third bucket. That means that the $10,000 in their first bucket is taxed at 10%, which means that they owe $1,000 in tax on that $10,000. ($10,000 x 0.10 = $1,000) The $30,000 in their second bucket is taxed at 12%, which means that they owe $3,600 in tax on that $30,000. ($30,000 x 0.12 = $3,600) The $15,000 in their third bucket is taxed at 22%, which means they owe $3,300 in tax on that $15,000. ($15,000 x 0.22 = $3,300) Putting these together, this person owes $7,900 on their $55,000 income. ($1,000 + $3,600 + $3,300 = $7,900)
These bracket sizes (the bucket sizes) and taxation rates are determined by Congress - they can set them however they like and apply them to whatever tax base they like.
Next: Read Who Pays the Tax?