Yesterday, the Tax Foundation released an updated report showing what the top effective marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. on labor would be in each state following an expiration of the Bush taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. cuts for high-income tax returns combined with the proposed surtax that has a top rate of 3 percent. It also includes many recent income tax hikes at the state level aimed at those tax returns at the top of the income spectrum.
Readers should note that these are effective marginal rates, not average rates. An effective marginal tax rate equals the amount of ADDITIONAL tax that a taxpayer would pay if she earned $1 more in additional income (in this case, labor income). The effective average tax rate for a taxpayer is her total tax paid divided by total income earned.
A rich person facing an effective marginal tax rate of 55 percent does not mean that the government takes 55 percent of all her income. It just means that government would take 55 cents of the NEXT dollar she earned.
For economic planning reasons, an individual should only be concerned with looking forward, or in other words, the marginal tax rate. What’s happened in the past is essentially irrelevant for decision-making purposes.
Marginal tax rates are what matter most for economic efficiency, which is why they are quoted extensively in the economic literature. If one believes that $1 in tax increase via marginal rate hikes is equivalent to $1 in tax hikes by eliminating the income exclusion for employer-provided health insurance, then that is an argument that average tax rates are what matter, not marginal rates.
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