Tax bands and marginal rates

Two numbers describe your tax, and confusing them causes most bad decisions.

Marginal vs effective

Your marginal rate is what the next pound you earn is taxed at. Your effective rate is your total tax divided by your total income. The marginal rate is always the higher of the two in a progressive system, sometimes dramatically so.

Which one you need depends on the question:

• "Is this overtime worth doing?" - marginal. You are asking about extra income.
• "How much do I actually pay?" - effective. You are asking about the total.
• "Should I put more in my pension?" - marginal, because relief applies at the rate the money would otherwise have been taxed at.

Do not forget the second stack

Income tax is not the only deduction with bands. Social contributions - National Insurance, PRSI, FICA - run on their own thresholds, and student loan repayments add another layer above their own threshold.

So your true marginal deduction rate on an extra pound can be income tax plus contributions plus student loan. That combined number is often 10 to 20 points higher than the income tax rate alone, and it is the honest figure to use when weighing extra work.

Cliff edges

Genuine cliff edges exist and are worth knowing, because unlike normal bands they can mean an extra pound leaves you worse off, or barely better off:

• Allowance withdrawal. In some systems the personal allowance tapers away above a threshold, creating an unusually high effective marginal rate through that band.
• Benefit or credit withdrawal. Child-related benefits and credits are often withdrawn as income rises.
• Childcare or housing support thresholds. Some are true cliffs - one pound over and the support stops entirely.

These are specific, countable and country-specific. They are not a reason to fear pay rises generally; they are a reason to check before making a decision near a known threshold. Pension contributions are frequently the tool used to stay under one, because they reduce the income that counts.

Use it, do not fear it

The practical takeaway: earning more essentially always leaves you with more. The question is only how much more, and the answer is your combined marginal rate.

Run a hypothetical rise through the mySal simulator and compare the gross increase to the net increase. Seeing the two side by side makes the concept permanent.