When it comes to taxes, there are two important concepts that you need to understand: marginal tax rate and effective tax rate.
Your Marginal tax rate is the rate at which you pay tax on your next dollar of income. For example, if your marginal tax rate is 32%, then you will pay 32 cents in tax for every dollar you earn over the tax threshold.
The Effective tax rate is the total amount of tax you pay as a percentage of your income. For example, if you earn $100,000 and you paid a total of $25,000 in taxes for the year, than your effective tax rate is 25%.
The difference between marginal tax rate and effective tax rate can be explained by the fact that tax brackets are progressive in Australia. This means that as your income increases, you move into higher tax brackets, where you pay a higher marginal tax rate on that portion of your income that falls within each bracket.
The table below shows the marginal tax rates for Australian tax payers as of Financial Year 22/23.
| Income thresholds | Rate | Tax payable on this income |
|---|---|---|
| $0 – $18,200 | 0% | Nil |
| $18,201 – $45,000 | 19% | 19c for each $1 over $18,200 |
| $45,001 – $120,000 | 32.5% | $5,092 plus 32.5c for each $1 over $45,000 |
| $120,001 – $180,000 | 37% | $29,467 plus 37c for each $1 over $120,000 |
| $180,001 and over | 45% | $51,667 plus 45c for each $1 over $180,000 |
As you can see from the table above, the more you earn the higher the rate tax that is applied but it is important to know that the higher rate of tax only applies to the portion of your income that falls within that specific bracket.
i.e.if you earned $90,000 in FY23 your tax would be as follows;
- $0 tax on the first $18,200 of income
- $5,092 for the income between $18,201- $45,000 at rate if 19%
- $14,625 for the income between $45,001 to $90,000 at a rate of 32.5%
So, what’s the point of all this?
The point is that you need to understand the difference between marginal tax rate and effective tax rate so that you can make informed decisions about your finances.
For example, if you are considering taking on a new job that will pay you more money, you need to factor in the increase in your marginal tax rate. This is because the extra money you earn may not be as much as you think after tax.
On the other hand, if you are considering investing in a tax-deductible investment, you need to factor in the fact that this will reduce your taxable income. This means that you may end up paying less tax overall, even though your marginal tax rate has increased.
So, there you have it. Marginal tax rate and effective tax rate are two important concepts that you need to understand if you want to make informed decisions about your finances.
And remember, the taxman’s always watching, so don’t try to pull any funny buggers.