February 2017
Marginal versus Effective Personal Income Tax Rates:
Understanding what you actually pay (paid) in income taxes
BY Alexandra Sirota, BTC Director
A great deal of confusion abounds in discussions about state personal income tax rates and how they
A great deal of confusion abounds in discussions about state personal income tax rates and how they
apply to income. This policy basic clarifies the difference between marginal and effective tax rates, and
apply
income.
This policy basic
clarifiesofth
e difference
between
gives atoNorth
Carolina-specific
example
how
these rates
work inmarginal
action. and effective tax rates, and
gives a North Carolina-specific example of how these rates work in action.
A taxpayer’s marginal tax rate is the tax rate imposed on his or her last dollar of income. In a progresAsive
taxpayer's
tax system,
rate is the
onhigher
his or her
lastofdollar
of income.
a progressive
personalmarginal
income tax
thetax
taxrate
rateimposed
applied to
levels
income
is higherInthan
the rate
personal
income
tax
system,
the
tax
rate
applied
to
higher
levels
of
income
is
higher
than
the
rate
applied to lower levels of income. Such a graduated rate structure is better able to keep up with a
applied
lower levels
income.
graduated
rateofstructure
is better
able todon’t
keep have
up with
a
growingtoeconomy
and of
ensure
that Such
thosea at
the bottom
the income
distribution
to carry
a
growing
economy
andthe
ensure
that those at the bottom of the income distribution don’t have to carry a
heavier tax
load than
wealthy.
heavier tax load than the wealthy.
How Marginal & Effective Tax Rates Worked in North Carolina Prior to 2013
How Marginal & Effective Tax Rates Worked in North Carolina Prior to 2013
Before 2013 tax changes, the first $21,250 of any taxpayer’s taxable income in North Carolina was taxed
Before
2013 tax
the first
taxpayer's
taxable
income
in North
Carolina
was taxed
at 6 percent,
thechanges,
next $78,750
was$21,250
taxed atof7any
percent,
and any
taxable
income
earned
over $100,000
at
6 percent,
next
$78,750
was
at 7 percent,
and any taxable
income earned
overincome
$100,000
was
taxed at the
a top
marginal
rate
of taxed
7.75 percent.
It is fundamental
to remember
that only
over
was
taxed at atax
topbracket,
marginal
of 7.75
percent.
is the
fundamental
to rate.
remember
that only this
income
over
the marginal
or rate
income
level,
is taxedItat
next higher
Put differently,
means
that
no
taxpayer
actually
pays
the
top
marginal
tax
rate
of
their
entire
taxable
income
in
state
personal
the marginal tax bracket, or income level, is taxed at the next higher rate. Put differently, this means
income
taxes. actually pays the top marginal tax rate of their entire taxable income in state personal
that
no taxpayer
income taxes.
So how great of a share of total income do North Carolina taxpayers actually pay in personal income
taxes?
question
is answered
by calculating
taxpayer’s
effectiveactually
tax rate,
which
is the share
of toSo
howThis
great
of a share
of total income
do Northa Carolina
taxpayers
pay
in personal
income
tal income
he orisshe
pays in by
taxes.
Taxpayers’
effectiveeffective
tax rates tax
are rate,
usually
much
lower
than
taxes?
This that
question
answered
calculating
a taxpayer's
which
is the
share
oftheir
total
marginal
rates.
Confusion
about
how
exactly
marginal
tax
rates
are
applied
to
personal
income
can
income that he or she pays in taxes. Taxpayers' effective tax rates are usually much lower than theirlead
individuals to believe that their taxes are much higher than they actually are.
marginal rates. Confusion about how exactly marginal tax rates are applied to personal income can lead
individuals to believe that their taxes are much higher than they actually are.
How Marginal & Effective Tax Rates Work Today in North Carolina
How Marginal & Effective Tax Rates Work Today in North Carolina
In 2013, North Carolina policymakers adopted a low, flat income tax rate and did away with a graduated2013,
rate structure.
Whilepolicymakers
some creditsadopted
and deductions
were
eliminated
reformed,
all awere
and
In
North Carolina
a low, flat
income
tax rateorand
did awaynot
with
graduated
manystructure.
have since
beensome
added
back to
tax code. were
At the
same time,
adopted
a
rate
While
credits
andthe
deductions
eliminated
or policymakers
reformed, nothave
all were
and many
higher standard deduction that they often call a zero tax bracket. In 2017, the income tax rate dropped
have since been added back to the tax code. At the same time, policymakers have adopted a higher
to 5.499 percent and the standard deduction increased to $17,500 for taxpayers married filing jointstandard deduction that they often call a zero tax bracket. In 2017, the income tax rate dropped to
ly. Under these tax policies, the effective tax rate on income now of 3.38 percent is far lower than the
5.499 percent and the standard deduction increased to $17,500 for taxpayers married filing jointly.
Under these tax policies, the effective tax rate on income now of 3.38 percent is far lower than the
5.499 percent tax rate and still lower
than the effective tax rate of 4 percent
paid on average by taxpayers before
the 2013 tax changes.
The change in the effective income tax
rate since the adoption of the low, flat
rate was not as great as the statutory
rate cut alone would suggest because
many credits and deductions were
eliminated to pay for the rate cut thus
broadening the base of income subject
to taxation. The elimination of credits
and deductions and the capping of the
value of itemized deductions, specifically mortgage interest and property
tax deductions at the state level, mean
that different taxpayers even within
the same income group could pay
different effective rates. This would be
based on decisions they make about
housing, college attainment, among
other choices.
It is also important to note that the
effective income tax rate varies by
income level. The decline in the effective tax rate has been greatest for
millionaires. As is evidenced in the
graph below, the change in the effective tax rate since 2013 for millionaires
has been far greater than for middle
income taxpayers.