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Tax brackets and progressive taxation

A progressive tax system is a tax in which the percentage of taxes paid (the average tax rate) increases as income increases. Income is broken down into tax brackets, and each bracket's marginal tax rate increases as you move into higher brackets. Learn how to use tax brackets to calculate income tax in this video. Created by Sal Khan.

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Video transcript

Voiceover: You'll hear the word "tax bracket" thrown around a lot, and there's often a misunderstanding of what a tax bracket is, so that's what we're going to do in this video. I'm going to do it in a very general, simple way that doesn't use the exact same tax code of any particular country, but most countries use some kind of a progressive tax system, that has some type of tax brackets. Let's say my country has a tax code that says between $0 of income and $10,000 of income you pay no taxes on it, and then between 10,000 and, let say, 50,000, let me write that a little bit neater, between 10,000 and 50,000, so that's 50,000 right over there, you pay 20% of your income, and then let's just say, this is very simple; much simpler than any actual tax codes out there; let's say anything above $50,000, you pay 30%. 30% of your income. The reason why I say that there is confusion here is many people feel that if their income throws them into a bracket, that they pay 20% on all of their money, but that's not the way it works. Let's just do a couple of examples. Let's say that someone earns ... let's say income, and then let's think about how much taxes they will pay. Let's say someone makes $5,000 in income. How much taxes would they pay? The first $10,000 you pay no taxes, so they'd pay $0 in taxes. Let's say someone has $15,000. $15,000 in income. How much taxes would they pay? They would pay 0% on the first $10,000, so it would be 0% x $10,000. x £10,000, and then the next 5,000, they're going to be right over here, the next 5,000 they're going to pay 20%. So, + 20% x the next $5,000. The next $5,000. They'll pay, this is just 0, then 20% of $5,000. They will pay $1,000 in taxes. The misconception that many people have is, "Oh, $15,000 puts me into this middle bracket, "so I'm going to have to pay 20% on all $15,000," and that's not the way it works. You only pay 20% for the increment that throws you in that bracket. Just for the $5,000. Let's do another example. Let's say that someone makes $100,000. Let's say that someone makes $100,000. $100,000. How much taxes would they pay? It wouldn't be that they're in this last bracket, so they'd pay 30% on their entire $100,000. They pay 0% on the first 10,000. 0% x 10; I'll just write "10K" for 10,000. Then they'll pay 20% on the next 40,000. This range right over here. So, + 20% x the 40,000, and then they only pay 30% on the increment of their income that is above this $50,000 threshold. Then they will pay 30%. They will pay 30% x the next $50,000, so 10,000 + 40 + 50. That's what adds up to $100,000. x $50,000. This adds up to, well, this is nothing. 20% of $40,000 is going to be $8,000. Then 30% of $50,000 is going to be 15,000. Is going to be $15,000. In this situation, the person will not pay 30% on the entire 100,000. They will pay 8,000 + $15,000, which is equal to $23,000 in income taxes.