In this short video we’ll explore taxation and distinguish between marginal and average
tax.
We will briefly explore the difference between proportional, progressive and regressive taxes.
We will wrap up with a discussion of the canons of taxation.
Simply put, the average tax is the amount of tax paid divided by income.
If I earn $100,000 and pay $25,000 in income tax, my average rate of taxation is 25%.
My marginal rate of tax is likely to be different.
It is the tax that I pay on my next dollar.
To clarify the difference, we will look at an example.
The first column lists the tax rates for single filers of US taxes in 2016.
Different levels of your income are taxed at different rates.
These ranges are visible in the second column.
For the third column we can see the taxes paid by each bracket for someone earning $100,000.
In the lower three brackets, 10%, 15% and 25%, the income earner is paying tax on the
full range of those brackets.
However, at the 28% range they are only paying tax on $8,850, which is the difference between
$100,000 and the lower limit of the bracket.
In the final column we can see how much tax has been paid at each level.
We calculate the total taxes paid as $21,036.75.
The average tax rate is that amount divided by $100,000 multiplied by 100%.
That gives us an average tax rate of 21.04%.
The marginal rate of tax would be 28% as the next dollar earned by this person would be
taxed at that amount.
What we’ve just seen is an example of a progressive tax, which taxes those with higher
incomes more.
As income increases, so does the average rate of taxation.
Proportional taxes take an equal percentage of income from all earners.
Several US states impose a proportional income tax - including Illinois, Michigan and Pennsylvania.
The US federal tax system is progressive.
Regressive taxes tend to take a greater portion of income from lower income earners.
VAT is an example.
To illustrate this, consider two people buying $100 worth of clothes and each individual
paying $20 worth of VAT.
If I earn $100 and use all my money to buy those clothes, I’ve paid 20% of my income
in tax.
However, if I earn $1000 and use just $100 of my money to buy those clothes, I’ve paid
2% of my income in tax.
This graph represents the different average rates of tax for each type of tax and how
they change as income increases.
As mentioned earlier, proportional tax remains equal to the average rate of tax throughout
all levels of income.
The average rate of tax increases as income rises with progressive taxes.
Finally, regressive taxes tend to have lower average rates of tax from higher income earners.
Adam Smith developed a set of criteria to judge the efficiency and equity of taxes.
These include the following canons:
The cost of collection must be low relative to the yield - collecting taxes should not
be an expensive endeavour and it would be best to minimise the expense of collection.
Second, the timing and amount to be paid must be certain to the payer - tax payers should
be clear about when and how much they will need to pay.
Third, the means and timing of payment must be convenient to the payer - it should be
convenient for the taxpayer to pay their taxes.
By making it difficult to do so, there will inevitably rise difficulties in collection.
Taxes should be levied according to ability to pay - taxes should not be shared equally,
rather it should be shared out by ability to pay and personal circumstance.
I hope this video helps you to better understand taxation - specifically what is required for
the CIE syllabus.
In unit 3, you should learn the difference between marginal and average rates of taxation.
Also, you should be familiar with the differences between proportional, progressive and regressive
taxes.
You should understand the canons of taxation.
In the later units we will take a more in depth look at taxes.
For now, leave any comments and questions below or email me at enhancetuition@gmail.com
or tweet me @enhancetuition.
Keep watching and I’ll see you in the next one.