A graduated rate income tax system consists of tax brackets where tax rates increase as income increases. Typically, this results in a taxpayer’s effective income tax rate, or the percentage of their income paid in taxes, increasing as their income increases.
Graduated-Rate “Progressive” Income Taxes
Unlike single-rate or “flat” income taxes, graduated-rate or “progressive” income taxes impose higher marginal tax rates on higher levels of marginal income. This reduces the payoff to additional work and investment on the margin and acts as a negative incentive on working more. As a result, compared to single-rate taxes, graduated-rate taxes are usually more harmful to economic growth, especially when the variation among rates is large and the top rate is high.
The U.S. federal individual income tax has a graduated-rate structure with seven tax brackets and rates ranging from 10 to 37 percent. For single filers in 2022, the first $10,275 in taxable income is taxed at a rate of 10 percent, the next $31,500 is taxed at a rate of 12 percent, the next $47,300 is taxed at a rate of 22 percent, and so on.
| Tax Rate | For Single Filers | For Married Individuals Filing Joint Returns | For Heads of Households |
|---|---|---|---|
| 10% | $0 to $10,275 | $0 to $20,550 | $0 to $14,650 |
| 12% | $10,275 to $41,775 | $20,550 to $83,550 | $14,650 to $55,900 |
| 22% | $41,775 to $89,075 | $83,550 to $178,150 | $55,900 to $89,050 |
| 24% | $89,075 to $170,050 | $178,150 to $340,100 | $89,050 to $170,050 |
| 32% | $170,050 to $215,950 | $340,100 to $431,900 | $170,050 to $215,950 |
| 35% | $215,950 to $539,900 | $431,900 to $647,850 | $215,950 to $539,900 |
| 37% | $539,900 or more | $647,850 or more | $539,900 or more |
| Source: Internal Revenue Service | |||
As an example of how marginal tax rates affect decision making, take an individual earning $41,775 in taxable income, meaning much of their income is taxed at the 12 percent rate. If this individual wants to work extra hours or take a second job, they would end up facing the 22 percent rate on their additional earnings. At that higher tax rate, they will bring home less take-home pay from their second job or additional hours of work, meaning the benefit they receive from working additional hours or taking a second job is reduced. This may influence the individual to decide not to take a second job or to work fewer hours than they may have chosen to otherwise because the benefit they receive from working more is reduced.
Similarly, high marginal tax rates can influence businesses to make investment decisions that minimize tax liability even if those decisions might not otherwise make the most sense from an economic or business standpoint.
Proponents of graduated-rate tax structures like the perceived fairness that comes from higher income earners paying higher rates than lower income earners, but this can also encourage economically inefficient decision making, reduce labor force participation, and weaken long-term economic growth.
Single-Rate “Flat” Income Taxes
A flat tax, where a single rate is applied to all taxable income, is an appealing income tax system due to its relative simplicity, transparency, neutrality, and stability. Flat taxes are relatively transparent and simple in that they make it easier for taxpayers to estimate their tax liability and for revenue forecasters and state policymakers to estimate how a rate cut or increase would impact revenue.
Importantly, flat taxes avoid impacting individuals’ and businesses’ marginal decisions, or what they will do with their next dollar of income. Whereas graduated-rate income taxes reduce the payoff to work and investment on the margin by imposing higher tax rates on higher levels of marginal income, flat taxes treat all taxable income neutrally and are less likely to discourage additional work, investment, and other activities that contribute to economic growth.
Because all income taxpayers are subject to the same tax rate under a flat tax system, single-rate taxes are generally more difficult to increase than graduated-rate taxes. This provides predictability to taxpayers and helps protect against unnecessary tax rate increases.
Most states that levy an income tax have tax systems similar to the progressive, graduated rate federal income tax, but nine states currently have a flat tax system, and four others have enacted laws to transition to a single-rate tax.
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