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Tax brackets and progressive taxation

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.