How do marginal tax rates influence overtime decisions?

• A. Each extra dollar is taxed at a fixed rate regardless of income
• B. Each extra dollar may be taxed at a higher marginal rate, reducing after-tax benefit
• C. The marginal rate decreases uniformly as income rises
• D. Marginal tax rates apply only to capital gains

Answer: (B)

Marginal tax rates show how much tax you owe on the next dollar you earn. When you work overtime, that extra pay can push some of your income into a higher tax bracket, so the additional dollar isn’t taxed at the same low rate as your regular wages. In practice, the after‑tax gain from overtime is the overtime pay times (1 minus the marginal rate in effect for that bracket), so the incentive to work extra hours can shrink if a higher bracket kicks in. If the overtime dollars stay within the same bracket, the after‑tax gain is larger; if you cross into a higher bracket, the gain is smaller because part of the overtime is taxed at a higher rate. This is why marginal tax rates influence overtime decisions: the tax is not a single fixed rate on all income, and higher brackets can erode the extra take‑home pay.