Question

Suppose George made 20,000 dollar last year and that he lives in the country of Harmony. The way Harmony levies income taxes, each citizen must pay 10 percent in taxes on their first 10,000 dollar in earnings and then 50 percent in taxes on anything else they might earn. So given that George earned 20,000 dollar last year, his marginal tax rate on the last dollar he earns will be entire income will be. a. 50 percent; 50 percent. b. 50 percent; less than 50 percent. c. 10 percent; 50 percent. d. 10 percent; less than 50 percent.

Short answer

b. 50 percent; less than 50 percent.

Step-by-step solution

Understanding Harmony's Tax System

In Harmony, the first 10,000 dollars of income are taxed at a 10% rate. Any additional income over 10,000 dollars is taxed at 50%.

Calculating George's Taxes

Split George's 20,000 dollar income into two parts: the first 10,000 dollars, and the remaining 10,000 dollars (20,000 - 10,000).

Calculating Tax on First 10,000 Dollars

George pays 10% on the first 10,000 dollars. Thus, his tax is 10% of 10,000 which is: \[ 0.10 \times 10,000 = 1,000 \text{ dollars} \].

Calculating Tax on Remaining Income

George pays 50% on the next 10,000 dollars. Thus, his tax for this portion is 50% of 10,000 which is: \[ 0.50 \times 10,000 = 5,000 \text{ dollars} \].

Total Tax Calculation

Add both portions of tax together for the total tax owed: \[ 1,000 + 5,000 = 6,000 \text{ dollars} \].

Average Tax Rate for George

To find the average tax rate, divide total taxes paid by total income: \[ \frac{6,000}{20,000} = 0.30 \text{ or 30%} \].

Key concepts

How Harmony's Tax System Works

Understanding the tax system within a country is crucial for its citizens. In Harmony, the tax system is structured in a way that initial income is taxed at a lower rate. This progressive tax system means that as you earn more, a higher portion of your income gets taxed at a higher rate.
In Harmony's case:

• The first $10,000 of income is taxed at 10%.
• Any income beyond $10,000 is taxed at a hefty 50% rate.

This creates two separate tax brackets, ensuring that individuals at different income levels contribute different amounts based on their earnings. This kind of system is designed to be equitable, ensuring that those who earn more pay a larger portion of their income in taxes.

What is Income Tax?

Income tax is a type of tax levied on individuals or entities (like corporations) based on the income they earn. Governments use this type of tax as a primary source of revenue to fund various public services like education, infrastructure, and healthcare.
Income can come from a variety of sources:

• Salaries or wages.
• Interest earned from savings and investments.
• Business profits.
• Dividends from stocks.

In Harmony, George's situation is a clear example of how income tax works. He made $20,000 and had to pay taxes in two brackets. This income tax system can also serve to reduce income disparity since higher earners typically pay more tax both in quantity and as a percentage of their income.

Understanding the Average Tax Rate

The average tax rate gives an idea of the portion of total income paid as taxes. It's calculated by dividing the total taxes paid by the total income earned.
For George:

• He paid \(6,000 in taxes on a \)20,000 income.
• The calculation is: \( \frac{6,000}{20,000} = 0.30 \), or 30%.

This means that, despite differing tax brackets and rates within his income allocation, 30% of George's total earnings went towards paying taxes. Understanding average tax rates helps taxpayers comprehend their actual tax burden and compare it against the marginal tax rate, which applies to their last dollar earned.