What are tax brackets? A tax bracket is a range of income that's taxed at a certain rate. Tax brackets
work like this. We'll start with a two column table and in header we'll put taxable income and
tax rate. In The Wizarding World personal income tax is progressive: as your income increases you
gradually move through higher and higher tax brackets which increases your average tax rate.
On the first 10,000 galleons that you earn during a tax year you pay no tax at all. Then from 10,000
to 40,000 galleons you're charged twenty percent tax. Between forty thousand and a hundred
thousand you pay thirty percent and any taxable income above 100,000 gallons incurs the highest
tax rate of 40 percent. Harry works as an Auror for the Ministry of Magic and earned 90,000
galleons during the tax year. How much tax does he owe and what is his tax rate? A common misconception
is that Harry would have to pay 30 percent tax on all of his income. But that's not how progressive
tax brackets work. You can think of tax brackets as cauldrons that we fill up with taxable income.
We start with the smallest cauldron or the lowest tax bracket and we fill it up right to the top.
Harry doesn't pay any tax on this income. Then we fill up the second one. Harry pays 20 percent on
this income, and then we fill up the third one. This time we don't make it all the way to the
top because Harry didn't earn 100,000 galleons. He pays 30 percent tax on his taxable income in this cauldron.
So how much tax does Harry owe? Let's jump back to our table where we've added a couple more columns.
On Harry's first ten thousand galleons he pays zero percent tax. In other words nothing.
Between ten thousand and forty thousand he's charged twenty percent. Thirty thousand multiplied
by twenty percent is six thousand galleons and then from forty thousand to his total taxable
income of ninety thousand he pays thirty percent. Ninety minus forty is fifty, and fifty thousand
multiplied by thirty percent is fifteen thousand galleons. Harry didn't earn over a hundred thousand
galleons so the bottom line of this table is irrelevant. Overall Harry owes personal income tax
of zero plus six thousand plus fifteen thousand a total of 21,000 galleons in personal income tax.
Let's look at this on a chart. As you can see tax brackets are progressive. As Harry earns more his
tax rate steps up and up and he pays higher and higher rates of tax. Harry does pay 30 percent tax
but only on his income above 40,000 galleons. This is his marginal tax rate. It's the highest rate of
income tax that he pays. His effective tax rate is his average tax rate across all his taxable
income. We can work that out by taking his total income tax payable and dividing it by his total
taxable income. That's 21,000 in tax divided by 90,000 in taxable income. Which is roughly 23 percent.
The following year Harry gets promoted to head of the Auror Office and receives a pay rise. This
increases his salary to 140,000 gallons per year. What impact does this have on his marginal and
effective tax rates? Before we jump into the answer you should know that I've summarized
everything I'm talking about in my tax brackets cheat sheet. It's available to buy on my website
and the proceeds help keep Accounting Stuff free from sponsors. The link's in the description.
On Harry's first 10,000 he pays nothing, the same as last year. On his next 30,000 he pays twenty
percent tax which is still 6,000 galleons. But this next tax bracket is a little bit different. Since
Harry now earns over 100,000 gallons he fills this cauldron up to the top. 60,000 multiplied by
thirty percent is eighteen thousand galleons. And finally, Harry pays 40 percent tax on his income above 100,000
galleons. Forty thousand multiplied by forty percent which is sixteen thousand galleons.
His total tax bill is zero plus six thousand plus eighteen thousand plus sixteen thousand
which is forty thousand galleons. If we jump back to the Chart we can see that Harry's marginal
tax rate has stepped up by 10 percent. It's now 40 percent. But this tax rate only affects his income above 100,000
galleons. His effective tax rate is his total income tax payable of 40,000
divided by his total taxable income of one hundred and forty thousand. That's
around 28 percent which is only five percent higher than his effective tax rate from last year.
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