What is Marginal Tax Rate?

5paisa Research Team Date: 15 Jan, 2024 03:31 PM IST

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In simple terms, the marginal tax rate refers to the tax rate applied to your next rupee of taxable income. As your income increases and you move into higher tax brackets, the marginal tax rate is the rate that applies to that portion of your income. The key thing to understand about marginal tax rates is that they apply only to the latest chunk of income, not the entire income.

Marginal tax rates determine how much tax you pay on any additional income you earn. For instance, suppose your annual taxable income increases from ₹5 lakh to ₹5.5 lakh. The marginal tax rate applies to that additional ₹50,000 you earned, not the entire ₹5.5 lakh amount. 

In this way, your marginal tax rate is the tax you pay on your next rupee earned. It goes up progressively based on income slabs - higher income is taxed at higher percentages.

Marginal Tax Rates Examples

Suppose your total taxable income is ₹5.8 lakhs. Up to ₹2.5 lakhs is tax-free. On the next ₹2.5 lakhs (2.5 - 5 lakhs slab), you pay 5% tax. On an additional ₹0.8 lakh, the marginal tax rate is 20%. So you pay:

• Nil tax on the first ₹2.5 lakhs
• 5% of ₹2.5 lakhs = ₹12,500
• 20% of ₹0.8 lakh = ₹16,000
• Total tax = ₹12,500 + ₹16,000 = ₹28,500

Marginal Tax Rates in India

Here are the income tax slabs and corresponding marginal tax rates in India:

Total Taxable Income Tax Rates As Per New Regime
Above ₹15 lakhs  ₹1,87,500 + 30% of total income exceeding ₹15 lakhs 
₹12.5 - ₹15 lakhs ₹1,25,000 + 25% of total income exceeding ₹12.5 lakhs 
₹10 - ₹12.5 lakhs ₹75,000 + 20% of total income exceeding ₹10 lakhs 
₹7.5 - ₹10 lakhs ₹37,500 + 15% of total income exceeding ₹7.5 lakhs 
₹5 - ₹7.5 lakhs ₹12,500 + 10% of total income exceeding ₹5 lakhs 
₹2.5 - ₹5 lakhs 5%
₹0 - ₹2.5 lakhs Nil

Importance of Marginal Tax Rate

Understanding marginal tax rates is key for:

Tax planning: Avoid jumping into higher brackets. Carefully manage income near slab thresholds.
Investment decisions: Applicable marginal tax rate impacts net returns on income generated. 
Salary raise decisions: Evaluate marginal tax impact to quantify the exact net increase in hand. 
Tax optimization: Enable optimization via deductions, exemptions, and rebates to minimize tax incidence. 

What is the Maximum Marginal Tax Rate?

The maximum marginal tax rate refers to the highest rate of income tax applicable to the top income slab.

As per India's Income Tax Act under Section 2(29C), the maximum marginal rate means the maximum rate of income tax, including any surcharges that apply to the highest slab of income.

This rate is specified in the Finance Act each financial year. Currently, it is applicable to individuals, associations of persons, or bodies of individuals with a total taxable income exceeding ₹5 crores annually.

Difference Between Effective and Marginal Tax Rates

Basis for Comparison Marginal Tax Rate Effective Tax Rate
Definition Tax rate applicable on the last rupee of income Average overall tax rate on entire taxable income
Scope Applicable to only an incremental slab of income Considers income as a whole based on tax brackets
Application Determines tax on additional income amount Calculates overall tax liability and average rate paid on entire taxable income
Implication Influences tax impact of future income-generation activities and helps tax planning accordingly Indicates average historical tax rate paid across total income earned in a given period

Conclusion

The marginal tax rate is the percentage of tax applied on the last slab of income earned. It goes up progressively for higher incomes based on income tax slabs and helps inform personal finance decisions on investments, tax optimization, salary increments, etc. Understanding marginal rates, as against the average effective tax rate, provides a better indication of potential tax impact on future income-generation plans and activities.

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