How do tax brackets function in personal finance?

Tax brackets function by taxing taxable income at different rates depending on the portion of income that falls within specific ranges. This means that as a taxpayer earns more, their income is taxed incrementally. Each tax bracket applies a different rate to the income that falls within that particular range.

For instance, if a tax system has multiple brackets, the first portion of income may be taxed at a lower rate, while subsequent portions are taxed at higher rates. This progressive tax structure is designed to ensure that those with higher incomes pay a higher percentage of their income in taxes compared to those with lower incomes.

Understanding this concept is essential for effective financial planning, as it impacts various decisions, such as how much to save, invest, or potentially defer income to remain within a lower tax bracket. This structured approach allows for a fairer taxation system, where individuals contribute according to their financial capabilities.