Question

Which of the following is FALSE of the progressive tax system in the U.S. for couples filing a joint tax return who earn more than $100,000 of income?

Select one:

a. The marginal tax rate starts out low (for low levels of income) and ends up high (for high levels of income.

b. The average tax rate will be greater than the highest marginal tax rate.

c. These couples will pay more in taxes compared to couples who make $50,000 of income

d. Total tax paid divided by total income earned is equal to the average tax rate

e. Income is separated into brackets, and the higher income amounts get taxed at a higher rate compared to lower income amounts

Answer 1

b. The average tax rate will be greater than the highest marginal tax rate.

For example, imagine income under $100,000 is taxed at 10%, income between $100,000 and $300,000 is taxed at 15% and income over $300,000 is taxed at 25%. Now consider individuals who both hit the upper tax bracket of 25% had taxable income of $360,000.

Individuals would pay 10% on their first $100,000 of income, or $10,000. And then pay 15% percent on their income between $100,000 and $300,000, or $30,000 (15% of $200,000).

Finally, also pay 25% on their earnings over the $300,000 threshold. For the individual with $360,000 in taxable income, that would come to $15,000 (25% of $60,000)

Their total tax obligations would be $55,000

Average Tax Rate (AVR) is 15.3% ($55,000 divided by $360,000)

or alternatively

Average Tax Rate (AVR) = Total Tax ÷ Taxable Income

Total Tax = Average Tax Rate (AVR) * Taxable Income

The highest marginal tax rate refers to the highest tax bracket into which their income falls.

Total Tax < Highest marginal tax rate * Taxable Income, as progressive income system

So, Average Tax Rate (AVR) < Highest marginal tax rate

i.e. 15.3% < 25%