What is the marginal tax rate?

The marginal tax rate is defined as the tax rate that applies to the next dollar of income earned. This concept is crucial in personal finance and tax planning because it indicates how much tax an individual will pay on an additional dollar earned. For example, if a taxpayer is in a tax bracket where the marginal rate is 25%, any additional dollar they earn will be taxed at that 25% rate. This information is vital for financial decisions such as salary negotiations, investment planning, and understanding the implications of additional income from various sources.

Understanding the marginal tax rate helps individuals make informed financial choices, especially regarding income growth. It gives insight into how much of their additional earnings will be retained after taxes. In contrast, the average tax rate, which is the total tax paid divided by total income, provides a broader view of overall tax burden but does not reflect the tax implications of earning just one more dollar. Thus, the emphasis on the next dollar of income distinguishes the marginal tax rate from other tax rate concepts.